1. Debt Administration Troy University PA6650- Governmental Budgeting Chapter 15

2. Overview Debt is a result of governments borrowing from individuals and institutions Bonds represent a debt that gives the borrower’s long-term promise to repay the lender –Bonds have a face amount and a maturity date –The nominal return on a bond is stated as its coupon rate DEBT RESULTS FROM: –Covering deficits –Financing capital projects –Covering short periods when bills exceed cash on hand

3. Federal Debt A result of: –War finance –Attempts to stabilize the nation’s macroeconomy –Miscellaneous political disputes The federal deficit –The difference between total federal spending and revenue in a given year Federal debt (national debt) - Two important measures: –Gross debt All federal debt outstanding –Debt held by private investors All federal debt except that held by federal accounts and the Federal Reserve System

4. Federal Debt Figure 15-1 on page 577 shows Federal Debt relative to GDP Table 15-1 on page 578 shows history of federal debt...it has grown considerably! Over 50% of privately-held debt is foreign- owned Most federal debt has short-term maturity (average 4 yrs/10 months)

5. State & Local Government Debt Currently near $2 trillion States, counties, municipalities, townships, school districts, special districts Mostly long term Two types of debt –Full-faith-and-credit debt (unlimited claim), usually issued as a General Obligation Bond (GOB) Schools, police stations, bridges –Non-guaranteed (or limited liability) debt, issued with a Revenue Bond Toll roads, water plants, revenue-producing infrastructure

6. State & Local Government Debt Municipalities are the largest users of debt markets Special districts are the heaviest users of non-guaranteed debt (waste, transit, water) School districts are heavy users of full faith and credit debt (schools don’t generate revenue) Non-guaranteed debt has significantly increased

7. Municipal Bonds and the Tax Reform Act of 1986 Interest on state and local government bonds is exempt at federal level Industrial Development Bonds (IDB’s) offer tax-exempt status for private development (controls) Registered bonds – owner specifically named Bearer bonds – whoever holds the bond

8. Appropriate Debt Policy Borrowing provides funds to acquire resources for public use –Debt must be repaid, with interest, in the future –Borrowing commits future budgets –Don’t issue debt for a period longer than the project’s useful life Economic growth requires infrastructure, and debt is not necessarily a bad thing Debt must be handled with care

9. The Mechanics of Bond Values Coupon bond example (p. 588) –15 year maturity (m) –30 semiannual periods (m x 2 = 30) –8% interest coupon rate C, but must use C/2) –$5000 face value (F) –6% market interest rate ® –Bond Price = $6,006

10. Debt Structure Decisions Type of security Term to maturity Call provision Rating –US government not rated (A+) –Three firms do bond rating Mergent Standard & Poor’s Fitch Investors Service / ICBA

11. Bond Rating –Rating criteria The economy Debt The government Financial analysis

12. Credit Enhancements A way to reduce the interest rates Third-party guarantee –State credit guarantees –Bank letters of credit –Municipal bond insurance

13. Underwriting, Interest Rates, and Ownership Bond bought by an individual investor, then sold at a slightly higher price (spread) to individual investors Important underwriter documents –Official statement –Legal opinion Bond issue…Sidebar 15-3

14. Lease-purchase Financing & Certificates of Participation Lease-purchase financing –an installment purchase –When fully paid, owner gets full ownership of the property Certificates of Participation –Investors buy them –Federal tax-exempt –Uses a nonprofit trustee –Useful to fund public infrastructure

15. Conclusion Debt exists because expenditure exceeds revenue Federal debt from annual deficits, state & local debt from capital projects Debt management important, and results in good ratings, careful tailoring of maturities and timing of debt issues, guarantees, etc. Debt itself is not evidence of poor fiscal management