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Girard Miller's Benefit Beat: Bonding with OPEB

Keep your powder dry!

BY: | April 2007



Some municipal bond underwriters are peddling the idea that public agencies should sell bonds now to "pre-fund" their promised retiree medical-benefit-plan liabilities.

Now that government accounting rules require disclosure of these Other Post Employment Benefits (OPEB) liabilities, public officials are looking for solutions, and some will be bedazzled by the idea of bond finance. An OPEB bond would raise cash to invest in a pension-fund- like portfolio of stocks and other securities--even including hedge funds--in hopes of earning a return higher than the borrowing cost, thus funding the liability.

How good an idea is this? The Government Finance Officers Association is wary. It's sending its members an "extreme caution" message. Not only is GFOA right, but even if bonding were the best solution for a jurisdiction, now is the wrong time to do it.

Selling bonds to buy a portfolio of market securities is always a risky business, but it's especially chancy at the tail end of a business cycle as the odds of a recession increase with every passing month. Some pension plans, for instance, sold pension bonds in 1998, two full years before the last market peak. They are just now above water after paying interest on their debts.

If you are going to sell OPEB bonds, heed the words of Baron von Rothschild and "wait until there is blood on the streets." That means waiting until the bottom of the next recession, when interest rates are near their cyclical lows and stock prices are trading cheap--at 25 to 30 percent below their cyclical peaks--with historically stronger prospects for superior long-term returns.

Before looking to the muni market for a solution, explore other alternatives for funding OPEB needs, including Voluntary Employee Benefit Associations and governmental-purpose trusts that may not even require borrowing. Then, if you determine that OPEB bonds are the best route, pull the trigger to sell bonds when the economy and the stock market look dismal and nobody knows where the market will bottom. By funding the portfolio after a recessionary downturn, your odds of executing an OPEB strategy that will be successful for decades to come will certainly improve.


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Girard Miller
Girard Miller

Girard Miller is the Public Money columnist for GOVERNING and a senior strategist at the PFM Group.

E-mail: millerg@pfm.com
Twitter: @governing

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