State and local governments pledge their full faith and credit to repay general obligation bonds, but politicians in Chicago and Connecticut realize their word is depreciating in value. Thus, they’re pitching a debt arbitrage to reduce their borrowing costs, according to a Wall Street Journal editorial. As part of Illinois’s bailout of Chicago, Democrats in Springfield this summer allowed the city to issue bonds securitized with $700 million or so in annual sales tax revenue, according to the editorial. Chicago plans to start floating the sales-tax bonds next month to refinance existing debt, and the bonds will be cheaper to finance than Chicago’s junk-rated GO bonds, which carry a 3.5 percent premium over top-rated municipal securities. Connecticut lawmakers recently authorized bonds backed by state income taxes as a substitute for GOs. The budget noted that “the new type of borrowing authorized in the bill may be viewed more favorably in bond markets because it is linked directly to a large and relatively stable revenue source,” according to the editorial. Puerto Rico likewise established a special public corporation in 2006 to issue sales-tax “Cofina” bonds, which were billed as more secure than debt paid from the commonwealth’s operating fund. For a time that appeared true, as politicians raised the sales tax (which was later converted into a VAT) to repay creditors. But last year, Puerto Rico’s governor issued a debt moratorium, which led Congress to impose a fiscal control board and create a quasi-chapter 9 bankruptcy process. Cofina and GO bondholders are now vying for the same small pool of money, and both will be lucky to get half of what Detroit bondholders recovered in its chapter 9.
