Not All Refinancings Are Created Equal

Abstract

In this ongoing era of fiscal stress, state and local governments have increasingly turned to financial measures to help balance their budgets. One financial tactic commonly employed is debt refinancing. This article details the common refinancing strategies employed by state and local governments. Based on these strategies, typical refinancing transaction types are constructed and evaluated based on an assessment framework that relies on four debt refinancing principles developed in this article. Based on this assessment framework, the article concludes with a series of general recommendations for state and local governments to consider when refinancing debt.

Keywords

municipal finance financial management public budgeting

Introduction

Because of the severe fiscal challenges caused by the Great Recession, state and local governments over the last several years have considered many different types of strategies to relieve budgetary pressure. In addition to traditional deficit-closing tactics like increasing taxes, cutting spending, and “downsizing” government, subnational governments have turned to financial measures such as debt refinancing to help balance their budgets. The debt being refinanced can take the form of “hard” liabilities like municipal bonds or so-called soft liabilities such as unfunded pensions and outstanding unpaid bills.

This is not an insignificant budget balancing strategy. In fact, for some governments, the use of debt refinancing as a budget balancing strategy may represent the largest part of the overall deficit reduction approach in a given year. For example, the City of Chicago relied on $142 million in budgetary savings from the category of “refinancing debt,” which closed almost 22 percent of the entire budget deficit in 2011. This represented the largest deficit reduction measure in the city’s budget in that year (Civic Federation 2011).

While the academic literature has examined some of the debt refinancing measures employed by state and local governments (Briffault 1996; Miranda and Rowan 2003; Petersen 2003; Miller and Justice 2011; Bifulco et al. 2012; Luby 2012a, 2012b; Denison and Gibson 2013), there has not been a systematic attempt to classify and assess them. This article attempts to make such a classification and evaluation by offering a framework for assessing the various different debt refinancing strategies used by state and local governments. This framework allows for a classification of various general refinancing strategies along a continuum of “prudent” and “imprudent” based on each strategy’s aggregate “score” on the four debt refinancing principles developed in the article.

To that end, this article does four things. First, it details examples of common refinancing strategies employed by state and local governments. Second, it develops four debt refinancing principles: intergenerational equity, economic efficiency, measurability/certainty, and management flexibility. Third, it constructs typical refinancing transaction types and then evaluates them on the multiprinciple assessment framework. Finally, the article concludes with a series of general debt refinancing recommendations for state and local governments to consider based on the developed assessment framework.

Refinancing State and Local Debt

Common Refinancing Strategies: Hard and Soft Liabilities

Like a person who refinances a home mortgage, the general thrust of state and local debt refinancing is an attempt to replace a current liability with a new liability carrying a lower interest rate. The reduction in interest rates leads to lower interest costs for a subnational government’s operating budget reducing the current year’s deficit and potentially deficits in future years. It is tempting to think of this only in the context of “hard” liabilities or the replacement of bonded debt for a state or local government’s previously sold municipal bonds. This is denominated a “hard” liability because the subnational government has entered into a legally enforceable contract for the full and timely repayment of principal and interest on the bonded debt. Thus, in this type of refinancing, the government replaces one “hard” liability (the old bonds) with another “hard” liability (the newly sold bonds).

However, state and local governments may also refinance “soft” debt. “Soft” debt includes other less predictable future liabilities such as pension payouts, unemployment trust fund benefits, or unpaid vendor bills. This type of debt is classified as “soft” because the full future liability and timeliness of payment can only be estimated. These vary based on factors such as fund investment performance, retirement rates, or actuarial calculations such as retiree life expectancy. In addition, they vary because repayment terms may be more flexible than bonded debt as in the case when state and local governments negotiate terms for repayment to vendors for goods and services.

In some cases, one type of debt may be used to replace another in a debt refinancing. State and local governments can use hard liability debt to refinance soft liabilities. For example, a state or local government may sell pension obligation bonds (POBs) and use the proceeds of the POB sale to reduce the unfunded accrued actuarial liability (UAAL) in the pension system. In this case, the UAAL is a soft liability being refinanced and the POBs are the hard liability used to replace the soft liability.

Principles of Prudent Debt Refinancing

Refinancing measures are usually lumped together under the umbrella category “debt refinancing.” Nevertheless, they can differ significantly on the relative degree of prudence involved in the refinancing. They can differ depending on the type of debt refinanced and the specifics of the refinancing strategy employed. One cannot assume that a particular refinancing measure used by a state or local government is prudent. In fact, to evaluate a debt refinancing measure on a continuum from prudent to imprudent, one needs to consider both the short- and long-run implications of the debt refinancing transaction.

The prudence of refinancing measures can be assessed based on principles that have been established in previous research on state and local government debt management strategies. For example, Johnson and Rubin (1998) and Luby (2009) used a framework of accountability, efficiency, equity, and effectiveness in measuring debt prudence. Bifulco et al. (2012) expanded the definition of state and local government borrowing to include the dimensions of certainty, measurability, and transparency. Based on the foregoing, this essay employs the following principles to assess the relative prudence of debt refinancing strategies:

Intergenerational equity: As it relates to debt finance, intergenerational equity refers to the incidence of a debt burden among different generations of taxpayers, both present and future (Johnson and Rubin 1998). That is, does the refinancing benefit one generation of taxpayers much more greatly than another generation or does the refinancing actually (or potentially) place an increased debt burden on one generation while actually or (likely) reducing the debt burden on another? Intergenerational equity in refinancing is most important when considering whether interest cost savings are spread equally or proportionally throughout the term of the bond issue or taken up front as governments can capture the timing of these refinancing savings in many different ways (all or mostly upfront, deferred, equal each year, or proportional). From the perspective of intergenerational equity, these transactions represent “prudent” refinancing as long as one generation is not burdened more than another. For intergenerational equity, refinancing where the savings are spread equally each year would be ideal. At the other extreme, a bond refinancing that “restructures” a hard or soft liability indebtedness by selling new municipal bonds to refinance and further amortize existing debt past the original maturity date of the refinanced indebtedness increases the debt burden placed on future generations. Such debt restructurings clearly violate the principle of intergenerational equity.

Economic efficiency: Economic efficiency in the context of bond refinancing is related to the opportunity cost of refinancing the debt later at a greater savings amount. This is called the time value option in a particular refinancing. An efficient refinancing is one in which this opportunity cost is minimal. That is, one in which the interest cost savings assuming the refinancing is executed today closely approximates the time value option of the refinancing (Kalotay and May 1998; Zhang and Li 2004; Kalotay, Yang, and Fabozzi 2007). Refinancing “timing” is especially important for the municipal bond market since the Internal Revenue Service generally limits subnational governments to only one refinancing of a bond more than ninety days in advance of its maturity. State and local governments can use time value option models to estimate economic efficiency. In general, debt-refinancing strategies that enhance economic efficiency include fixed rate municipal bond refinancing of existing bonded indebtedness that are efficient with respect to the time value option and using fixed rate bonds to refinance nonbond liabilities with higher interest rates.

Measurability/certainty: As a general debt finance principle, “certainty” refers to the likelihood that a government will have to forgo future resources and “measurability” assesses the feasibility of valuing the amount of such foregone resources (Bifulco et al. 2012). In the context of debt refinancing, the certainty and measurability concepts are combined and a bit different. Specifically, this concept measures whether the interest cost savings of a refinancing can be measured (measurability) and are “locked-in” (certainty) at the transaction’s execution. For example, a fixed rate bond refinancing of bonded indebtedness promotes this principle as the government entity will know upfront the specific level of its refinancing savings since the interest costs on both the new and old bonds are fixed throughout the term of the transaction. Typical strategies used to undermine this principle are taking savings based on an unguaranteed arbitrage benefit and using financial derivatives in a refinancing that may or may not ultimately “enhance” refinancing savings.

Management flexibility: Management flexibility refers to the degree that a refinancing has constrained or freed a government entity’s future financial decision making. For example, converting a “soft” liability to a “hard liability” limits management flexibility as the state or local government generally has much more control in the timing of payment of its soft liabilities than it does with payment to investors of its bond liabilities. As such, one of the most commonly utilized strategies undermining this principle is bond refinancing of nonbond liabilities.

State and Local Debt Refinancing Transactions: Using a Framework for Assessment

The previous section of this article developed the notion of prudent debt refinancing based on the principles of intergenerational equity, economic efficiency, measurability/certainty, and management flexibility. In practice, of course, state and local governments often employ transactions that include multiple facets of the applied principles based on the adopted strategy. This section of the article applies the four debt refinancing principles to five typical refinancing transaction types as a means of offering an assessment framework continuum for transaction prudence.

Transaction Types

This article posits basic five debt refinancing transaction types. The transaction types represent various refinancing strategies that include transactional features related to the previously discussed debt refinancing principles. To that end, the types include refinancing of both hard and soft liabilities, different interest savings structures approaches, and different time value option approaches. The transaction types illustrate the debt refinancing assessment framework continuum, provide definitions, and real-world or textbook examples for each transaction. In addition, these transaction types also represent most (although not all) of the general refinancing strategies employed by state and local governments.

Fixed rate bond refinancing of bonded indebtedness that is efficient with respect to the time value option and interest cost savings are spread equally throughout the term of the bond issue

The first transaction example is one that rates high on economic efficiency since the time option value is maximized. It measures high on intergenerational equity since the interest cost savings are spread equally among taxpayer generations. Measurability/certainty is high since the state or local government can measure the interest cost savings of a fixed-rate bond refinancing at closing and such savings are locked-in throughout the term of the transaction. Management capacity is deemed “high” since there is really no effect on the limit of the government’s future financial flexibility since the refinancing is assumed to refund an existing hard liability (i.e., existing bonds). This transaction example rates highest on overall refinancing prudence as it measures “high” on all four debt refinancing principles.

Example: A hypothetical refinancing analysis provided by municipal finance expert Andrew Kalotay and prepared for the Securities Exchange Commission illustrates this type of refinancing transaction type (Securities Exchange Commission 2011). Kalotay analyzed a refinancing as of October 2011 for a City of Seattle, Washington serial bond due October 1, 2013, with a coupon of 4 percent and a par amount of $4,345,000. Assuming four different refinancing interest rates, Kalotay calculated the economic efficiency of each scenario. Kalotay calculated that if Seattle could sell refinancing bonds with interest rates between 0.264 percent to 0.564 percent, the present value savings would be realized at efficiency ratios at least 90 percent (i.e., Seattle would realize at least 90 percent of the time value option). Each of these scenarios represented an economically efficient refinancing since most of the time option value was realized.

Fixed rate bond refinancing of bonded indebtedness that is efficient with respect to the time value option and interest cost savings are structured upfront.

This transaction rates high on economic efficiency since the time option value is maximized. It measures low on intergenerational equity since the interest cost savings benefit the current generation with no interest cost savings benefits realized by future generations. Measurability/certainty is high since the state or local government can measure the interest cost savings of a fixed-rate bond refinancing at closing and such savings are locked-in throughout the term of the transaction. Management capacity is deemed “high” since there is no effect on the limit of the government’s future financial flexibility since the refinancing is assumed to refund existing bonds.

Example: The City of Chicago’s Series 2011 sales tax revenue bonds that refinanced over $200 million in outstanding general obligations bonds evidences this transaction type (City of Chicago 2011). The city calculated the benefit of a sales tax refinancing compared to a general obligation refinancing as approximately 0.50 percent reduction in the true interest cost of the bonds which produced $1.3 million per year in additional interest cost savings or $15 million in additional interest cost savings over the life of the bond issue (interview with City of Chicago debt manager May 22, 2012). In this example, the city capitalized on unique market opportunities using a creative debt refinancing structure to enhance the economic efficiency of the transaction. However, the refinancing was used to “restructure” a portion of its outstanding general obligation bonds by amortizing the new bonds in later years compared to the refinanced bonds. The “restructuring” aspect of this transaction compromised the intergenerational equity principle for the transaction.

Fixed rate bond refinancing of bonded indebtedness that is inefficient with respect to the time value option and interest cost savings are structured upfront.

This transaction rates low on economic efficiency since the time option value is not maximized. It measures low on intergenerational equity since the interest cost savings benefit the current generation with no interest cost savings benefits realized by future generations. Measurability/certainty is high since the state or local government can measure the interest cost savings of a fixed-rate bond refinancing at closing and such savings are locked-in throughout the term of the transaction. Management capacity is deemed “high” since there is no effect on the limit of the government’s future financial flexibility since the refinancing is assumed to refund existing bonds.

Example: The Board of Education of the City of Chicago’s Series 2010F General Obligation Bonds is an example of this transaction type. This transaction represented a generic general obligation bond refinancing that extended the debt of the Board of Education an additional ten years from the original maturity date of the refinanced bonds while providing significant budgetary benefit in the first three years after the transaction (Board of Education of the City of Chicago 2010). The refinancing did not rely on any creative financing approach to enhance economic efficiency, but it did place a significant increased debt burden on future Chicago taxpayers while benefiting the current generation through reduced near-term debt service costs.

Fixed rate bond refinancing of an unfunded pension liability with expected arbitrage benefit realized throughout term of bond issue.

This type of transaction, known as a POB rates moderate on economic efficiency based on the uncertainty of the performance of the POB with most POBs not providing an arbitrage benefit through the end of 2010 (Munnell et al. 2010) although some have provided a benefit through 2012. It scores moderate on intergenerational equity because the arbitrage benefit is structured to benefit current and future generations although such benefit may not be realized in the future, which would burden those future taxpayers. Measurability/certainty is low since the state or local government cannot measure the arbitrage benefit of POBs at closing due to the uncertainty of future pension fund investment performance. Management capacity rates “low” since the government entity has replaced a soft liability that includes a relatively high degree of repayment flexibility with a hard liability that offers much more rigid repayment terms.

Example: The State of New Jersey Series 1997 POB issue evinces this transaction type. New Jersey sold $2.7 billion in POBs to convert its soft liability of unfunded pension liabilities to a hard liability of pension bond indebtedness. The infusion of POB proceeds reduced the state’s need to fund its pension funds in 1997. It was also expected that the earnings on the pension bond proceeds would exceed the interest cost on the POBs going forward so that the transaction would continue to reduce the state’s necessary pension contributions into the future. Unfortunately, such arbitrage benefits have mainly not been realized to date due to the volatility of the equities market since the POB’s issuance (Benner 2009).

Fixed rate bond refinancing of an unfunded pension liability with expected arbitrage benefit realized upfront.

This type of transaction rates moderate on economic efficiency based on the uncertainty of performance of recent POBs. It measures low on intergenerational equity since the arbitrage benefit is taken upfront favoring the current generation over future generations of taxpayers (assuming there are arbitrage benefits). Measurability/certainty is low since the state or local government cannot measure the arbitrage benefit of POBs at closing due to the uncertainty of future pension fund investment performance. Management capacity rates “low” since the government entity has replaced a soft liability with a hard liability. This transaction example rates lowest on overall refinancing prudence as it measures “low” on three of the four debt refinancing principles.

Example

The $10 billion State of Illinois Series 2003 POB issue offers a good example of this transaction type. The state used this “arbitrage play” transaction to convert a soft liability into a hard liability. It also used all of the projected arbitrage savings to reduce pension payments in 2003 and 2004 with projected saving in future years expected to be minimal. As of 2012, the arbitrage savings have swung wildly since the POB’s issuance as a result of extreme volatility in equity returns between 2003 and 2012 (State of Illinois 2012). Moreover, like all pension bond arbitrage plays, there is no guarantee that by the final maturity of the transaction any arbitrage savings will be realized.

Analysis

Table 1 provides a visual depiction of the debt refinancing framework for these five transaction types. It also includes an example of each transaction type as detailed previously. Each refinancing transaction type is assessed on the four debt refinancing principles with an assessment of whether the refinancing principle is “highly” supported (score of “2”), “moderately” supported (score of “1”) or “lowly” supported (score of “0”). A transaction receives a score of “high” or “low” on a refinancing principle if it is clearly observable and certain that it supports or undermines, respectively, the principle throughout the entire time period of the transaction. It scores “moderate” if there is uncertainty whether the transaction will support the principle over the transaction’s entire time period. The scores for each refinancing principle are summed up to provide a total overall score for the transaction type. Summing up the score on each debt refinancing principle, the highest score possible for a transaction type is “8” and the lowest score is “0.” By summing up the totals for all refinancing principles, the table provides an assessment framework continuum for evaluating each transaction type. The greater the overall score, the more the refinancing transaction type is deemed “prudent” along the assessment framework continuum. The lower the score, the less “prudent” such strategy is deemed along the continuum.

Table 1.

Assessment of Refinancing Transaction Types.

Refinancing Transaction Type	Refinancing Principle	Refinancing Principle Score Rating
Fixed rate bond refinancing of bonded indebtedness that is efficient with respect to the time value option and interest savings spread equally. Example: City of Seattle, Washington, Series 2011 (hypothetical example from Andrew Kalotay)	Economic efficiency	2 (high)
	Intergenerational equity	2 (high)
	Measurability/Certainty	2 (high)
	Management flexibility	2 (high)
	Total score: 8
Fixed rate bond refinancing of bonded indebtedness that is efficient with respect to the time value option and interest savings taken upfront. Example: City of Chicago Sales Tax Revenue Refunding Bonds, Series 2011	Economic efficiency	0 (low)
	Intergenerational equity	2 (high)
	Measurability/Certainty	2 (high)
	Management flexibility	2 (high)
	Total score: 6
Fixed rate bond refinancing of bonded indebtedness that is inefficient with respect to time value option and interest savings taken upfront. Example: Board of Education of the City of Chicago, General Obligation Bonds Series 2010F	Economic efficiency	0 (low)
	Intergenerational equity	0 (low)
	Measurability/Certainty	2 (high)
	Management flexibility	2 (high)
	Total score: 4
Fixed rate bond refinancing of an unfunded pension liability with expected arbitrage benefit realized throughout term of bond issue. Example: New Jersey Economic Development Authority, Series 2010	Economic efficiency	1 (moderate)
	Intergenerational equity	1 (moderate)
	Measurability/Certainty	0 (low)
	Management flexibility	0 (low)
	Total score: 2
Fixed rate bond refinancing of an unfunded pension liability with expected arbitrage benefit taken upfront. Example: State of Illinois Pension Obligation Bonds, Series 2003	Economic efficiency	1 (moderate)
	Intergenerational equity	0 (low)
	Measurability/Certainty	0 (low)
	Management flexibility	0 (low)
	Total score: 1

As shown in Table 1, the most prudent debt refinancing was a “fixed rate bond refinancing of bonded indebtedness that is efficient with respect to the time value option and interest cost savings are spread equally throughout the term of the bond issue.” This transaction scored “high” on all four debt refinancing principles for a total score of “8.” The transaction type that scored lowest was a “fixed rate bond refinancing of an unfunded pension liability with expected arbitrage benefit realized upfront.” This transaction scored “low” on intergenerational equity, measurability/uncertainty, and management flexibility. This transaction scored “moderate” on economic efficiency for a total score of “1.” The other three debt refinancing transaction types scored between “2” and “6” with these transactions high or moderately supportive of at least two or more of the principles but lowly rated on at least one of the principles as well.

Recommendations for Practice

The development of the assessment framework as illustrated in Table 1 taken together with the previous description and evaluation of bond refinancing strategies suggest some recommendations. These recommendations emanate from the strengths and weaknesses of the five refinancing transactions as described in Table 1. Thus, each recommendation aims to mitigate one or more of the flaws observed in the four transactions that scored below a perfect total score of “8.” As such, the recommendations aim to “move” debt refinancing transactions executed by state and local governments closer to the “prudent” end of the assessment framework continuum. In addition, the assessment framework can be extended with new elements to consider in the future. Even with such changes in the future, the recommendations can serve as general guideposts for state and local governments in crafting debt refinancing transactions that are as prudent as possible.

Carefully Evaluate Debt Restructuring Strategies

Debt restructuring violates the principle of intergenerational equity and this type of refinancing is generally economically inefficient. If state and local governments decide to execute a debt restructuring, they should adopt policies that quantify and disclose the additional interest costs associated with these actions so the citizenry understand the long-term financial trade-offs associated with the benefits of reduced debt service in the near term. In addition, governments should not describe debt restructurings that do not provide net present value savings as “refinancing” as many citizens assume “refinancing” necessarily provide net interest cost benefits. Such transactions should be clearly described in terms of “restructuring” debt with the long-term impacts detailed.

Disclose Which Taxpaying Generation Benefits from Upfront Refinancing Structures

Like debt restructuring, upfront savings structures violate intergenerational equity. Proportional or equal annual saving structures are much more prudent as it relates to equity. These structures also do not create or exacerbate structural budget deficits considering such debt refinancing strategies effectively serve as “one-shot” revenues. As an active means of discouraging such structures, state and local governments should also be required to disclose the interest savings schedule by year for all bond refinancing so the public knows in what years the savings are being captured.

Calculate the Time Value Option and Make It Available to the Public for All Traditional Bond Refinancing for Savings

Taxpayers need to know the specific trade-offs associated with debt management decisions. By calculating and disclosing the time value option of the proposed refinancing, state and local governments will allow taxpayers to understand what the opportunity cost is from executing the refinancing today. That is, such calculations will allow taxpayers to know the level of economic efficiency achieved in the transaction. Time option analysis is definitely feasible as The Bond Buyer currently offers a free service to its subscribers an advance refunding calculator, which provides basic time value option analysis for refinancing. In addition, bond issuers should demand that their financial advisors provide more sophisticated time value option analyses as part of their package of services whenever evaluating potential refinancing. Related to this, state and local governments should never rely solely on static net present value savings threshold metrics (e.g., 3 percent interest savings as a percentage of refinanced par) in deciding to execute a refinancing or not as such metrics do not contemplate the time value option but only the intrinsic value. That said, state and local governments should set a dollar savings threshold (e.g., in addition to 90 percent efficiency, the refinancing has to provide at least $500,000 in savings) to make sure the time and effort associated with the refinancing is a good use of staff time.

Avoid Refinancing That Involves Risky Arbitrage Schemes or Do Not Provide Guaranteed Benefits

The interest cost savings associated with debt refinancing should be “locked-in.” That is, in the parlance of the debt refinancing assessment framework, the interest cost savings should be “measurable” and “certain.” Otherwise, one could be executing transactions that do not provide any economic benefit if the interest savings fail to materialize, which could severely compromise intergenerational equity if the future generation has to bear a greater financial burden as a result of the refinancing. This is especially true for refinancing with interest rate swap derivatives where the economics of the transaction are subject to future market conditions. In the case of “arbitrage plays” like POBs, these transactions are incredibly risky and should generally be avoided especially for state and local governments whose finances are already shaky. The Government Finance Officers Association (GFOA: 2005) advises significant caution in evaluating the use of POBs (). To the extent they are executed, the arbitrage benefits should never be “taken upfront” which only exacerbates the riskiness of the transaction and reduces its overall intergenerational equity. In addition, if such transactions are considered, state and local governments should analyze them on a risk-adjusted cost of capital basis that looks at thousands of scenarios for different interest rate, market, volatility, credit quality, and tax-event scenarios as a means of determining the likelihood of extreme scenarios and how well the issuer can tolerate such scenarios from a budgetary perspective.

Recognize the Differences and Implications between Refinancing Hard and Soft Liabilities

Converting a soft liability into a hard liability, the case of traditional bond refinancing of liabilities such as pension obligations and unemployment trust fund benefits, may reduce the future management flexibility of a state and local government. For example, the debt service on POBs is a hard liability that must be repaid back in full and on time or there could be severe credit market implications. Reducing payments into a state or local government’s pension funds does not likely entail such credit market implications, at least in the short term. Moreover, such bond refinancing may reduce the bonding capacity of the state or local government. That said, the credit rating agencies increasingly do not make distinctions between soft and hard liabilities in assessing the financial condition of the government. As such, refinancing a soft liability with a hard liability is not, by definition, “imprudent.” That is, if it is economically compelling to refinance nonbond liabilities with bond liabilities, state and local governments should consider such a strategy.

Continue to Monitor the Bond Markets for Unique Refinancing Opportunities

The uncertainty and volatility in the state and local credit markets has provided subnational governments the opportunity to use creative strategies to enhance the economic efficiency of their refinancing. Given the likely continuing uncertainty of subnational finances in the near future, such volatilities and opportunities are likely to continue. State and local governments should encourage their capital market partners (i.e., their underwriters and financial advisors) to actively monitor the bond markets for such opportunities and bring creative refinancing ideas to their attention. The regular monitoring of market opportunities is a good way for state and local governments to increase the likelihood that they will be able to execute a refinancing with an efficiency ratio that is as high as possible.

Limit Statutory Constraints Placed on Debt Managers in Their Debt Refinancing Decision Making

While there is evidence that some state and local governments use imprudent refinancing strategies (see Petersen 2003; Miller and Justice 2011; Bifulco et al. 2012; Luby 2012a; Denison and Gibson 2013), there is also evidence that debt managers often try to maximize equity and efficiency on these transactions (Luby 2012b). While it could be argued that state and local governments that have regularly exercised imprudent decision making should be constrained by statute, it has also been shown that in some instances decreased managerial autonomy can lead to suboptimal financial decisions/results compared to debt managers who possess more bureaucratic decision-making power (Luby 2009). Thus, too many restrictions on debt managers may constrain their ability to maximize the principle of economic efficiency in their debt refinancing activities. The refinancing disclosures advocated previously would likely go a long way toward educating stakeholders of the long-term implications of debt refinancing strategies and likely keep in check the short-term decision-making instincts of elected officials and their finance managers. If stakeholders do not feel such disclosures are adequate, the creation of an outside debt oversight committee or board could serve to protect taxpayers if such institutions could flexibly provide guidance on executing refinancing.

Conclusion

State and local governments are increasingly exploring financial options, such as debt refinancing, to address their fiscal shortfalls. This article described and evaluated the common debt refinancing strategies employed by subnational governments in the United States. As shown in the transaction types, subnational refinancing activity is not only relegated to bonded indebtedness but also can involve the refinancing of many other types of liabilities. However, the relative prudence of any debt refinancing strategy is a matter of detail and often depends on the specific structure of the transaction. Taxpayers and other stakeholders need to be aware of the short- and long-term effects of particular refinancing strategies to understand the efficiency, intergenerational equity, measurability/certainty, and management flexibility impacts of these transactions.

The debt refinancing assessment framework presented in this article can help conceptualize such issues and trade-offs while the policy recommendations can be used to guide policy makers to make better long-term decisions, as it relates to refinancing activities of these governments. Given the continuing fiscal stress subnational governments expect to face in the next few years, it is likely that new refinancing strategies will be explored by these governments. The assessment framework and recommendations offered in this article should be just as useful to policymakers for any new developments that may arise in the future in this area of debt management.

Footnotes

Declaration of Conflicting Interests

The author declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author received no financial support for the research, authorship, and/or publication of this article.

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