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Pension Obligation Bonds

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Pension obligation bonds were a great idea for about a minute and a half in 1985 when the city of Oakland, California used them. Oakland issued tax exempt bonds at a prevailing rate for tax exempt bonds and then turned around and invested the money in vehicles such as Treasury Bills offering higher rates of interest. The Federal Government then passed a law making this sort of arbitrage by municipal and state governments illegal. As these folks could no longer issue tax free bonds for the sole purpose of reinvesting at a higher rate of interest the idea of pension obligation bonds seemed to go away. Fundamental analysis would seem to tell us that, without the ability to issue tax free bonds at lower interest rates, states should avoid these vehicles.

However, when interest rates when down and the stock market surged in the 1990’s the idea of pension obligation bonds returned. The idea was to borrow now and pay later with the promised returns of a booming stock market. At the time these states were able to issue taxable bonds at prevailing interest rates and gain more in the market. These states thought they were picking new winners with the booming market. Remember the Dot Com bubble? We have had two market crashes since the early 1990’s with the Dot Com bubble burst and the more recent market crash. Now the states that believed so strongly in a booming market are looking at these bonds again as a means of pushing debt obligations into the future. As of the end of 2009 California has issued roughly $13 Billion, Illinois $12 Billion, Oregon and New Jersey $4 Billion each, Connecticut, Pennsylvania and Wisconsin $3 Billion each, Michigan, Texas, and New York $2 Billion each, and so forth in these bonds.

The Center for Retirement Research (CRR) at Boston College has just issued a report on Pension Obligation Bonds written from the perspective of the states who issue them. We would like to look at these bonds from the viewpoint of anyone who might want to invest in them. According to RRC public pensions are less than 80% funded requiring over $200 Billion over the next five years to make up the shortfall. States that are already having trouble handling their budgets are looking to push more debt into the future. The sad fact is that, according to CRR, virtually no pension obligation bonds issued since are in the black. If your choices are investing in oil when the world needs energy, investing in beer when the world needs a drink, investing in gold as economic chaos threatens, or investing in bonds issued by states that are heavily in debt and sorely in need of fiscal discipline what do you do?

States are in a bad fix with huge obligations and diminished resources as tax revenues have dropped. They need to do something and pension obligation bonds may well be a good choice, for them. You, however, have money for stock investing in many different types of stocks. You can invest in options, futures, or foreign exchange. State and municipal bonds have traditionally been considered safe investments. The day may come when these bonds are considered junk bonds. It is probably a good idea to look elsewhere for long term safe, profitable investments.

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