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Bonds & Debt

Bonds & Debt. What Is It?. Disguised money creation (federal only) Real (you have to repay it, plus interest!) Federal State Local. Types: Full Faith & Credit . A.K.A. General Obligation or GO Is guaranteed debt Government pledges its taxing power to defray the debt

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Bonds & Debt

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  1. Bonds & Debt

  2. What Is It? • Disguised money creation (federal only) • Real (you have to repay it, plus interest!) • Federal • State • Local

  3. Types: Full Faith & Credit • A.K.A. General Obligation or GO • Is guaranteed debt • Government pledges its taxing power to defray the debt • Is a contractual obligation of the issuing government • For investors, it is the safest, most secure, sort of bond - sells at lowest interest rate

  4. Types: All Other • Non-guaranteed, e.g. revenue, industrial development, “moral” obligation, etc. bonds • Are riskier investments • Cleveland, New York • Washington Public Power Supply System (WPPSS) default in 1983 - $225B • Higher interest rates

  5. Who Holds The Paper? • Private U.S. citizens (“widows & orphans” investment) • Commercial U.S. banks • State & local governments • Foreign • Individuals • Commercial institutions • Governments

  6. Maturity Mix

  7. Maturity • Old style - borrow for as long as possible • e.g. 19th century British consols - never repaid • Current - borrow long or short term, depending upon anticipated changes in cost of borrowing • “Rolling over” - issuing new bonds to retire old ones

  8. Interest Rates • Are a cost to government • Are set by market, but government bonds enjoy a special position, due to • Tax exemption - bond holder does not pay federal income tax on interest income from state & local bonds (also true for some state income taxes)

  9. Interest Rates, cont. • This means that government bonds can be marketed for less (at lower interest rates) • Rate is also determined by bond’s relative security • GO sell for lowest rate • Track record, etc. have an impact

  10. Costs To Issuing Governments • Interest • Brokerage house fees • Government determines its needs, firm determines interest rates, maturity structure, etc. • NIC & TIC are ways of determining the costs of the brokerage house’s bid to the government

  11. Costs Are Affected By • Government’s experience in bond market • Competition • Supply (the number of other public issues in the market) • Demand (more means lower interest rates) • Competing brokerage houses • Bond (credit) rating - security of investment • Moody’s, Standard & Poor’s, Fitch’s

  12. Costs Are Affected By, cont. • Bond maturity date • Borrowing frequency • More often - lower rates (experience, knowledge of current conditions), but • For smaller governments, holding off on small issues & bundling them into larger “omnibus” bonds seems to pay off (Robert Bland)

  13. Private Purpose Public Debt • Involves using low-interest public bonds to finance development that would largely benefit private business • Had been a popular local development tool, but

  14. Private Purpose Public Debt, cont. • In the 1980's, reforms in federal tax law made this much more difficult • Issuing authority must be able to show that only a minor amount of the project being funded will benefit private enterprise • Tax exempt Industrial Development Bonds (IDBs) abolished

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