posted by Mike Madison at 7:13 AM /
[For background, read this post about the Mt. Lebanon Commission's decision to authorize a 20-year $2 million "wrapped" bond to pay for road and sidewalk repairs, and then read this post that critiques the Commission's decisionmaking process.]
We're going to do our best not to let this issue die a quick death. Not because the amount of money at stake is so great, either to the Municipality as a whole or to any individual taxpayer. In fact, the amounts of money are quite small -- which is part of the problem. Instead, it's a salient issue because of the signal that it sends about the quality of Municipal governance -- which is, in this case, atrocious -- and about municipal finance. This post follows up on that last point.
What's so bad about using bonds to pay for road repairs? What's so bad about using "wrapped" bonds, which back-load the nominal cost of paying off the bonds? And what's so bad about long-term bonds? I raise all of these questions because an anonymous commenter, someone who appears to have a position on Wall Street (or in the financial world, at least) wrote in to say, basically, that this deal is obviously the right thing to do. If you're buying an asset that lasts twenty years, then it's smart to amortize the cost over twenty years. The message "chill," you ignorant suburbanites.
Our blog rules prevent me from posting the comment (the commenter knew that), but the point is worth rebutting.
The question to start with is whether road and sidewalk repairs ordinarily should be classified as a capital expense (or investment) or an operating expense. If roads are ordinarily regarded as capital assets, then logic suggests that the Municipality should issue a new bond for every round of improvement. That strikes me as idiotic, but perhaps that's just my ignorance. It might make sense in the abstract to finance road improvements from a pool raised from a general obligation issue, but then the length of the bond and the amortization schedule aren't going to bear any logical relationship to the useful life of the roads, because different roads have different lives, and the money will be spent over a period of time. When I bought my house, I didn't get a mortgage with a term that was linked to the expected life of the house, or to the length of time that I expected to occupy it. I got a mortgage of a certain length and certain amount because the combination of products available in the market, likely refinancing needs and timing, payment amounts, and tax benefits made the most sense to me. How long I planned to own the house was a factor -- but hardly a determinative one. In other words, simple "matching" of bond life and asset life doesn't answer any question worth asking. The question is economics.
That brings us to "wrapping," or delaying re-payment of the better part of the bond obligation until the end of the bond. [Later, with a bit more time, I'll post a link to a thorough analysis by Bill Matthews that explains clearly how this works in this particular case.] To claim that "amortizing the bond over 20 years makes sense because the roads will last 20 years" misses a key point -- that amortization schedules can vary dramatically, and in this case the amortization schedule avoids burdening the current taxpayer by putting an enormous burden on the next-generation taxpayer.
To use round numbers, the current $2 million bond will end up costing the taxpayers about $3 million to repay, over 20 years. In nominal terms, that's a huge interest charge. What about present value terms? In present value terms, the discounted amount might be relatively small, assuming a very small interest rate. $3 million over $2 million means an interest rate of 2-3%. But Wall Street wishes for a lot of things -- we're all now living through the consequences of "wishing won't make it so" -- and there is zero reason to suppose that we're looking at 2% or 3% rates over the next 20 years. I'm not saying that Mt. Lebanon will actually have to pay back more than the scheduled 2-3% interest. [A careful reader called me to note that the total payback is closer to $4 million, which means that the interest rate is closer to 3% than to 2%.] But if Mt. Lebanon doesn't have the cash lying around 20 years ago to do that, and to make the large back-end payments in particular, then it will -- you guessed it -- have to borrow money again. And at what rate? Just like my mortgage and my anticipated ability to refinance it in the future if I need or want to, because I'm banking on home values rising or interest rates falling or both, a 20-year bond these days is a gamble, where the odds aren't as clearly settled in your favor as they used to be.
Just about every critical comment that I've read on this topic has invoked the "credit card" analogy, as in "you can pay your bills with your credit card, but you'll end up paying in the end, regardless." There are times when it makes sense to pay bills with a credit card -- when the card has a guaranteed low rate that's better (lower) than the return that you're getting on your money elsewhere. If you look at it that way, a $2 million bond issue isn't an expense so much as an investment. To take the most generous interpretation, Mt. Lebanon is paying $2 million of its money -- its tax revenues -- at 2% over the next 20 years. Is it making more than that with the money that it's not spending, or spending on other things?
And is there any evidence that this kind of analysis and evidence to back it up -- amortization, present and future values and so on -- motivated the Commission's decision?
We're going to do our best not to let this issue die a quick death. Not because the amount of money at stake is so great, either to the Municipality as a whole or to any individual taxpayer. In fact, the amounts of money are quite small -- which is part of the problem. Instead, it's a salient issue because of the signal that it sends about the quality of Municipal governance -- which is, in this case, atrocious -- and about municipal finance. This post follows up on that last point.
What's so bad about using bonds to pay for road repairs? What's so bad about using "wrapped" bonds, which back-load the nominal cost of paying off the bonds? And what's so bad about long-term bonds? I raise all of these questions because an anonymous commenter, someone who appears to have a position on Wall Street (or in the financial world, at least) wrote in to say, basically, that this deal is obviously the right thing to do. If you're buying an asset that lasts twenty years, then it's smart to amortize the cost over twenty years. The message "chill," you ignorant suburbanites.
Our blog rules prevent me from posting the comment (the commenter knew that), but the point is worth rebutting.
The question to start with is whether road and sidewalk repairs ordinarily should be classified as a capital expense (or investment) or an operating expense. If roads are ordinarily regarded as capital assets, then logic suggests that the Municipality should issue a new bond for every round of improvement. That strikes me as idiotic, but perhaps that's just my ignorance. It might make sense in the abstract to finance road improvements from a pool raised from a general obligation issue, but then the length of the bond and the amortization schedule aren't going to bear any logical relationship to the useful life of the roads, because different roads have different lives, and the money will be spent over a period of time. When I bought my house, I didn't get a mortgage with a term that was linked to the expected life of the house, or to the length of time that I expected to occupy it. I got a mortgage of a certain length and certain amount because the combination of products available in the market, likely refinancing needs and timing, payment amounts, and tax benefits made the most sense to me. How long I planned to own the house was a factor -- but hardly a determinative one. In other words, simple "matching" of bond life and asset life doesn't answer any question worth asking. The question is economics.
That brings us to "wrapping," or delaying re-payment of the better part of the bond obligation until the end of the bond. [Later, with a bit more time, I'll post a link to a thorough analysis by Bill Matthews that explains clearly how this works in this particular case.] To claim that "amortizing the bond over 20 years makes sense because the roads will last 20 years" misses a key point -- that amortization schedules can vary dramatically, and in this case the amortization schedule avoids burdening the current taxpayer by putting an enormous burden on the next-generation taxpayer.
To use round numbers, the current $2 million bond will end up costing the taxpayers about $3 million to repay, over 20 years. In nominal terms, that's a huge interest charge. What about present value terms? In present value terms, the discounted amount might be relatively small, assuming a very small interest rate. $3 million over $2 million means an interest rate of 2-3%. But Wall Street wishes for a lot of things -- we're all now living through the consequences of "wishing won't make it so" -- and there is zero reason to suppose that we're looking at 2% or 3% rates over the next 20 years. I'm not saying that Mt. Lebanon will actually have to pay back more than the scheduled 2-3% interest. [A careful reader called me to note that the total payback is closer to $4 million, which means that the interest rate is closer to 3% than to 2%.] But if Mt. Lebanon doesn't have the cash lying around 20 years ago to do that, and to make the large back-end payments in particular, then it will -- you guessed it -- have to borrow money again. And at what rate? Just like my mortgage and my anticipated ability to refinance it in the future if I need or want to, because I'm banking on home values rising or interest rates falling or both, a 20-year bond these days is a gamble, where the odds aren't as clearly settled in your favor as they used to be.
Just about every critical comment that I've read on this topic has invoked the "credit card" analogy, as in "you can pay your bills with your credit card, but you'll end up paying in the end, regardless." There are times when it makes sense to pay bills with a credit card -- when the card has a guaranteed low rate that's better (lower) than the return that you're getting on your money elsewhere. If you look at it that way, a $2 million bond issue isn't an expense so much as an investment. To take the most generous interpretation, Mt. Lebanon is paying $2 million of its money -- its tax revenues -- at 2% over the next 20 years. Is it making more than that with the money that it's not spending, or spending on other things?
And is there any evidence that this kind of analysis and evidence to back it up -- amortization, present and future values and so on -- motivated the Commission's decision?
2 Comments:
Mike, yet another angle to this story should focus on whether or not the Commissioners are even listening to their constituents. Specifically, if you've paid any attention at all in this community over the last 2 years you would know that one of the chief complaints about our community is the quantity and quality of our athletic fields.
How does this dovetail with the street bond issue? Well, the original plan was to include the $2 million in street work in a larger bond ($7 million) for field improvements. Ask yourself, would this pill be so bitter (or so bizarre) if the recent debt instrument was being used to improve/expand our athletic fields as well as to improve a few streets? Not to me, and certainly not to the thousands of families in this community whose children use these facilities on a daily basis.
To add insult to injury, the Peters Twp Commissioners floated a $6 million bond this week to improve their field space and expand Peterswood Park. If you've ever been to Peterswood Park, you might be scratching your head wondering what about it needs to be improved - or expanded. It's an awesome facility. In comparison to Mt. Lebanon, it is world class! Interestingly, the Commissioners in Peters argued that in the race to attract young families to their community, this was something that they felt compelled to undertake.
I'm not advocating a "keeping up with the Joneses" mentality; however, when you combine the constant requests of the community for better fields, the competitive aspects to home buying in the S. Hills, and the bizarre aspects of this limited bond issue, you are left scratching your head. I'm left wondering whether anyone is listening. What happened to the idea of issuing a bond for field space in Mt. Lebanon? How did these 11 streets (that no one seems to be complaining about) win out, while the loud cry for better athletic fields continues to go unanswered?
Please post a link to Bill Matthews *wrapping* analysis as well as a spreadsheet analysis he prepared that you may have of annual bond financing of $1 million of street reconstruction over a period of 20 or more years. Then ask the anonymous financial expert to render a fresh opinion after he/she faces the underlying facts.
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