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« Annual Lacrosse Posting | Main | The Sot-Weed Non-Factor »

Revenue Bonds Follies

Apparently, companies charged with estimate traffic flows on toll roads - the rates of return that price the roads' funding bonds in the market - have been cooking the books the make their government clients happy. The governments, apparently not understanding how the municipal bond markets work, figured the underwriters would adjust the numbers downward. But that's the underwriters' job. Their job is to price the bonds (frequently on competitive bid), based on the information they're given by the state and its contractors. Bad information in this case leads to low interest rates, defaults, and general taxpayer and bondholder unhappiness.

If this happened in private business, there's be perp-walks, frog-marches, howls of indignation, calls for the banning of bonds as unsafe investments, tsk-tsking about the inherent corruption of multinational corporations, and legislation making CEOs and CFOs personally responsible for the accuracy of the assessment.

Which is all you need to know about how governments treat themselves, as opposed to how they treat business.

In fact, though, there is a perfectly good free-market solution to the problem, one that will kick in soon enough. Most revenue bonds carry bond insurance. The insurers take on the responsibility to pay both interest and debt, should the bonds default. If estimators keep cooking the books to make bonds look better than they are, then the value of having insurance (to the investors) will rise; municipalities that don't have insurance will have to pay higher interest rates; and those that do have insurance will find their insurance premiums rising. In short, because nobody trusts what they're investing in or insuring, municipalities will have to bear an uncertainty premium along with the real rates of return their projects justify.

Another alternative would be to have the underwriting syndicates pay for their own studies, although since they also have an incentive to sell the bonds at the best price, it's hard to see where this helps the investor.

Then, there will be an incentive for the projecting companies to be right, not just popular. A company that finds itself right more often than its competitors will be giving the bond underwriters, investors, and insurance companies something to hang their hats on. Even if the company tends to make conservative estimates, the knowledge that they know what they're doing will reduce or eliminate the uncertainty premium described above.

Sure beats another federal agency.


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The (Mis)Behavior of Markets

The Wisdom of Crowds

Inventing Money

When Genius Failed

Blink: The Power of Thinking Without Thinking

Back in Action : An American Soldier's Story of Courage, Faith and Fortitude

How Would You Move Mt. Fuji?

Good to Great

Built to Last

Financial Fine Print

The Day the Universe Changed


The Multiple Identities of the Middle-East

The Case for Democracy

A Better War: The Unexamined Victories and Final Tragedy of America's Last Years in Vietnam

The Italians

Zakhor: Jewish History and Jewish Memory

Beyond the Verse: Talmudic Readings and Lectures

Reading Levinas/Reading Talmud