It’s a strategy that’s becoming increasingly common—municipalities, straddled with outstanding pension obligations, issue bonds to cover near-term funding shortfalls.
In a particularly risky iteration of the practice, cities and states will take the proceeds from selling the bonds and re-invest them into the market.
That’s exactly what Michigan is gearing up to do, according to Bloomberg:
The Detroit suburb of Macomb County plans a $270 million sale of municipal debt, its biggest ever, to finance retiree health-care costs, while Kalamazoo is considering a historic $100 million bond offer for similar expenses. Bloomfield Hills plans to borrow a record $17 million for pensions. The law allowing the practice expires Dec. 31.
U.S. states and cities are struggling with how to pay for promises to workers after the recession ravaged their finances. Yet few communities see debt as the answer — sales of revenue-backed pension bonds have tallied $356 million this year, data compiled by Bloomberg show. Interest rates close to five-decade lows are making it more attractive to pursue the risky strategy of investing borrowed funds in financial markets.
“We can’t afford to wait,” said Peter Provenzano, Macomb County finance director. “Timing the market is difficult. You could sit on the sidelines and miss out on an opportunity.”
It’s a risky strategy that’s been covered many times before, perhaps best by the Center for Retirement Research’s recent brief.
The gist: If a city is going to re-invest proceeds from issued debt, they better hope the market produces returns that exceed the cost of servicing the debt.
The problem is, most cities that turn to this practice are already in dire straits fiscally. If the bet doesn’t pay off, it leaves cities even worse off.
At least one Michigan city is shying away from the practice: Grand Rapids.
“The best way to have odds in your favor is to do this when stock prices are depressed,” Scott Buhrer, the city’s chief financial officer, told Bloomberg. “We’re in the latter stage of a bull market.”
Photo: “Kalamazoo” by User Mxobe on en.wikipedia – own-work. Licensed under Public domain via Wikimedia Commons