ShmoopTube

Where Monty Python meets your 10th grade teacher.

Search Thousands of Shmoop Videos

Principles of Finance: Unit 5, Rating Muni Bonds 4 Views


Share It!


Description:

How are muni bonds rated? Because, uh... we don't see any numbers for them on Rotten Tomatoes. Mainly, it has to do with risk.

Language:
English Language

Transcript

00:00

Principles of finance ah la shmoop rating Munity bonds with

00:05

ketchup With cheese with onions With mustard with your asha

00:09

with plum sauce All right Well think communi bond ratings

00:16

Lots of variables go into investor taste when they put

00:19

money into a munich bonn grated in a given class

00:22

Well most of the ratings revolve around who stands behind

00:25

paying off the munich bond Should things you know go

00:28

awry a different kind of rye bread With that out

00:32

of here as in most things financial the most important

00:34

element here is price or ah that is risk adjusted

00:38

price The more risk investors perceived investing in immunity bond

00:43

while the more return or interest they will demand for

00:45

him parting with their precious pennies So let's take the

00:48

nickel tour or the you know five trillion dollar tour

00:51

here of credit rating's in mini bond land Okay so

00:54

credit ratings check these out right here moody standard poors

00:57

fitch Yes they matter especially with munich bonds high credit

01:01

ratings imply high financial stability of municipality and low risk

01:04

of default This powerful combo usually means lower interest rates

01:09

for the city Seeking to build a new park expand

01:12

a parking volume thing near the mall and or widen

01:15

their sewer from a three inch pipe toe one that's

01:17

four feet wide Coinciding with the city's new embrace of

01:21

high fiber diets i don't think about that a bunch

01:24

of factors affect the rating itself One key element revolves

01:28

around the perceived stability of the entire region that is

01:31

an area which regularly votes in tax increases or special

01:36

tax assessments for projects well usually garner higher ratings and

01:41

cheaper debt then areas which have drawn a line in

01:45

their tax bill and said you know read my lips

01:48

all right next up ability to pay a municipality that

01:51

already has a lot of outstanding debt is just like

01:54

a corporation that has a lot of outstanding debt regardless

01:57

of how senior this new debt purport to be While

02:00

the chances of default are still hire you want to

02:03

look at its credit history Has it paid other debt

02:05

on time Ever defaulted in the past Doesn't have wealthy

02:09

city neighbors who would bail it out in times of

02:12

crisis Well the key focus is the ability to pay

02:15

test here which focuses on the municipalities ability to collect

02:19

taxes and nor fees on things like sewer hook up

02:23

you know for new homes real estate tax transactions and

02:26

cable egress and door rite of passage and fees and

02:29

tolls so that enough net profits are coming into the

02:32

city so that paying off their debts and more less

02:35

on time is a layup And yes munich bonds funded

02:38

the city basketball courts as well There Thank you very

02:40

much So you know what a deadbeat debtor is right

02:43

Well it's someone who took out alone promised to pay

02:46

it back and then re nig leaving the person who

02:48

loaned them the money in a pickle Well the same

02:51

thing happens with cities Local politicians want to look like

02:55

heroes of the moment and find ways with all kinds

02:58

of false promises to borrow money and build that social

03:01

aquarium Everyone has been jonesing for called fish book Unfortunately

03:06

the throngs of munich people may or may not show

03:08

up in schools A city lives on its taxes It

03:11

levees them It hopes that everyone pays but they don't

03:14

They just don't know Sadly there has to be a

03:17

collection ratio Thats the dollar amount actually collected divided by

03:21

the dollar amount levied Like normally you'd expect a given

03:24

city to collect well over ninety nine percent of the

03:27

taxes it bills But in tougher economic times a bunch

03:30

of nail salons when they can go bankrupt and skip

03:33

found without paying their tax bill and they do a

03:35

low collection ratio is a sign that the city is

03:38

economically unstable or a kind of falling apart Just is

03:42

in corporate america there are debt covenants while the munich

03:45

bonn world has the same limitations Thank goodness unfettered in

03:49

many cities just like congress would vastly overspend their budgets

03:53

trying to do good for their towns I you look

03:56

like heroes get reelected etcetera but taking everyone to the

04:00

poor house in the process by borrowing money they had

04:03

no hope of ever paying back so most cities have

04:06

ceilings on how much debt they can issue It may

04:09

be based on total tax revenues collected or a specific

04:12

dollar amount per head or an index which includes a

04:15

running average of interest rates or some other combination thereof

04:19

But just as in corporate america where a debt to

04:21

even the ratio of a greater than five acts number

04:24

makes investors really nervous and thus the bonds usually carry

04:28

very high interest rates the same or less is true

04:31

for in municipalities Let's think about how population factors into

04:35

this issue Well you'd expect san francisco a very populated

04:39

city to carry a lot more debt with its masses

04:42

of wealthy populace Then you'd expect from say peoria illinois

04:47

a large population usually bodes well for general obligation Munib

04:52

bonds remember these air the bonds backed by the full

04:54

faith and credit or the general obligation of the entire

04:57

city so usually pretty safe because of a geo bond

05:00

ever didn't pay well it would sort of mean the

05:03

end of the financial life of the city think today's

05:06

detroit and related lee of equal import are trends in

05:10

the population It's a problem if your city is crumbling

05:13

and everyone is moving out of it to the burbs

05:16

or to another state because well in the debt doesn't

05:18

disappear even though your taxpayers do remember that nineteen sixty

05:23

three detroit wass the silicon valley of the country our

05:27

best and brightest graduates from harvard on down would do

05:30

anything to get a job building and selling this new

05:32

huge growth industry called cars but as you know that

05:36

didn't work out so well Well most local schools make

05:39

their money from real estate taxes the local public schools

05:42

borrow money against the promise of future taxes coming from

05:45

real estate in their area when the value of homes

05:48

goes up a lot Well usually the taxes collected from

05:51

those homes also goes up a lot and life is

05:54

grand when the tax base is growing And when you

05:57

think about rating munich bonds while growing areas usually mean

06:00

higher ratings and cheaper capital cost to the borrowing city

06:04

that's right the borrowing the money gets cheaper things are

06:06

good right And there are a few other sources of

06:08

municipal revenue You have sales taxes and finds like this

06:12

parking meter people which can be a big part of

06:15

the municipalities revenue base And yes so stupid parking people

06:19

are actually a positive line item from the income statement

06:21

of most is stupid idiots can't believe they get paid

06:25

so much money All right we're moving on Another big

06:28

concern of mu ni investors is the big ugly specter

06:31

of unfunded incheon liabilities Okay so what is a pension

06:35

And one is a liability Well in california and illinois

06:38

and a few other highly indebted states for decades politicians

06:42

wanted to coddle Police and firemen and other unions because

06:45

they wanted to look good their constituents and get re

06:48

elected and other than burglars and arsonists Well who doesn't

06:52

like cops and fireman not talking to you The nfl

06:55

but politicians negotiated and their advisors presumed that their state's

06:59

economy would always remain strong and grow to infinity Over

07:02

time his taxes corrupt upward businesses and highly taxed old

07:07

people who are wealthy began leaving the state and then

07:09

the internet made telecommuting and other things dramatically easier to

07:13

manage remotely like from cheaper red states So the relative

07:17

tax dollars per person started to decline is the wealthy

07:21

and just a lot of business began to leave the

07:23

states in Suddenly cities inside the state could no longer

07:26

afford the armies of cops and fireman and other infrastructure

07:29

they had grown and it was one piece of very

07:32

bad legislation that harmed things financially for the cities police

07:35

and fire and other unions created a structure which most

07:38

cities followed blindly in any given city with saving one

07:42

hundred thousand people there likely dozens and dozens of cops

07:45

who are retired taking home fifty to one hundred fifty

07:48

thousand dollars a year for doing nothing in pension winnings

07:52

which taxpayers will pay until those cops died decades later

07:56

the policemen earned fifty going to one hundred fifty grand

07:58

a year working for the state for the city for

08:00

for thirty years retiring at age fifty five Then in

08:04

these highly indebted states many of these people keep something

08:06

like eighty five percent of their final few years salary

08:09

average for the rest of their lives meaning that for

08:11

the next twenty thirty forty years of their existence they

08:14

can sit around on their porch swatting flies and get

08:16

something like ten grand a month for doing nothing Well

08:19

this political chicken ary ended up being a huge liability

08:22

for many millions of dollars per year For big and

08:25

small cities alike The cry from the local population was

08:28

the cutbacks would have to be made to the police

08:30

force and that this was dangerous for the locals Well

08:33

when a local dennis asked about cutting back the ludicrously

08:36

high pinch and grants teo retired cops and fireman you

08:40

could imagine that the retired cops weren't too happy about

08:43

the suggestion And for good reason They did nothing wrong

08:45

They just cut The best deal they could with politicians

08:48

Unfortunately for the taxpaying population smart cops cut the deal

08:53

with idiot politicians who weren't really looking out for the

08:56

people who elected them In response it is sadly common

08:59

now to read about cities simply firing their entire police

09:02

and fire departments and having outsource them to rent a

09:05

cop Organizations who aren't subject to the owner of state

09:08

managed pension systems The rent a cop organizations pay fair

09:11

wages but don't suffer huge pension liabilities and the jury

09:14

is out as it were in determining whether this will

09:17

save cities balance sheets or not But early returns look

09:20

good and because the pension liabilities have become such a

09:22

large line item in city budgets well though garner a

09:25

lot of more scrutiny going forward So why does all

09:28

this matter to rating munich bonds Well you know where

09:31

the devil lives And yeah all of these details in

09:34

sum total have an effect on the financial performance of

09:36

cities and of states most of whom are poised precariously 00:09:40.395 --> [endTime] on mountains and mountains and mountains of debt

Up Next

GED Social Studies 1.1 Civics and Government
39794 Views

GED Social Studies 1.1 Civics and Government

Related Videos

Fake News
11938 Views

How do you tell fake news from real news?

Finance: What is Bankruptcy?
260 Views

What is bankruptcy? Deadbeats who can't pay their bills declare bankruptcy. Either they borrowed too much money, or the business fell apart. They t...

Finance: What is a Dividend?
1777 Views

What's a dividend? At will, the board of directors can pay a dividend on common stock. Usually, that payout is some percentage less than 100 of ear...

Finance: How Are Risks and Rewards Related?
589 Views

How are risk and reward related? Take more risk, expect more reward. A lottery ticket might be worth a billion dollars, but if the odds are one in...