Pension Obligation Bonds
Personal obligation bonds are financing maneuvers that make it possible for local governments and states to ‘wipe out’ pension liabilities that are unfunded by borrowing against future tax revenues. Once this is done, it is followed by investing proceeds in equities and other cases, high yield investments.
The reasoning behind this is that the investments will lead to higher returns than the interest rates on the bonds thus earning money for the pension fund. While it is a gamble, it is one that most governments are ready to take. Pension obligations bonds:
- Are debt securities that are used to fund ‘unfunded accrued actuarial liabilities’ in pension public plans
- Are always, almost issues as taxable debt
- Are issued as fixed term or fixed rate securities or as fixed term, variable securities.
- Typical security is in the form of the issuers general fund pledge.
Pension plans mostly face major losses and it is because of the local revenue and dearth of state that pension obligation plans are viewed as the most favorable tool for fixing pension woes. Some of the major issuers of pension obligation bonds include Illinois, New Jersey, Oregon, California and Connecticut.
In the recent past though, these bonds have taken on some form of notoriety when 2 California cities San Bernardino and San went bankrupt. Generous pensions that were propped awkwardly and with pension obligation bonds that were ill times contributed to the debacle. Also, over the years, the returns made on pension obligation plans often fall below the interest rate the locality or state paid in order to borrow the money as such, digging deep into the liability hole.
Despite this fact, these bonds still remain a favorite among many politicians in revenue pinch. It is easier to politically borrow money in order to pay the cost of pensions rather than squeeze a budget that is already stressed. Many policy holders and economists view pension obligation bonds as risky gimmicks and they even question the high market growth assumptions that make them appear viable.
However, defenders of these bonds believe that with proper timing, they can pay off. The first bond was launched in 1985 in Oakland, California and at that time, it appeared a reasonable strategy. This is because it qualified as a tax free bond and could be issued at low municipal bond rates.
A city or state could then pivot and invest the fund in securities that were safer but the strategy was ended by the 1986 Tax Reform Act that prohibited local governments and state from reinvesting for profits money from tax free bonds.
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