An Issue Brief issued by the Center for State and Local Government Excellence, Pension Obligation Bonds: Financial Crisis Exposes Risks, points out that after the recent financial crisis, most POBs issued since 1992 are in the red. The researchers suggest that the risk comes when the wrong governments issue POBs at the wrong time.
According to the report, governments with well-funded pension plans and sound fiscal health might find POBs advantageous if issued at periods when interest rates are particularly low. “This type of issuer could shoulder the additional risk of a POB without jeopardizing its fiscal health,” the researchers wrote. “Issuing a POB may allow well-heeled governments to gamble on the spread between interest rate costs and asset returns or to avoid raising taxes during a recession.”
However, the researchers note that the data shows that governments with healthy pensions and solid fiscal positions have historically not issued POBs. Rather, the governments that issue POBs are those facing the greatest fiscal stress and least able to shoulder the additional risks from a POB.
POBs are taxable general obligation bonds that governments issue to finance pensions. They transfer a current pension obligation into a long-term, fixed obligation of the government.
The report can be downloaded from here.