<p>johnnzen:</p>
<p>You’ve asked enough questions for a book. I’ll try to answer them without writing one:</p>
<p>A “bond” is a loan that’s structured so that the money to be loaned can come from hundreds or thousands of investors (vs. one or a few banks). The idea is that there’s a trustee in place so that the borrower (the city) doesn’t have to deal with all the lenders individually, and they don’t have to deal individually with the city or worry that some lenders will be treated better than they are. They are also structured so that the lenders can sell their piece of the loan, the bonds, or buy more, without recasting the whole deal, and so that prospective purchasers can easily understand what the deal is and compare it to others.</p>
<p>Interest on municipal bonds is usually tax-exempt on three levels – federal, state, and the issuing municipality (if it has an income tax, like NYC). That means that a lender does not pay income tax on the interest to any of those taxing authorities (but may have to pay state income tax if the lender resides in another state). That also means that the interest rate on the bonds is much lower than the interest rate on corporate bonds, so the city pays less interest overall.</p>
<p>As with any commercial loan, there is an infinite variety of repayment mechanisms and security arrangements for municipal bonds. The city may pledge its “full faith and credit”, or repayment may be limited to a specific revenue stream (often the case with project bonds), which may be something like rent revenue, or revenue from a specific tax, or some slice of tax revenues. The bond trustee may have a security interest in specific assets, like a stadium or properties reposessed for taxes, or uncollected tax receivables. That is more common when repayment depends on a specific, related revenue stream.</p>
<p>Most city and state laws require voters to approve some or all bond issues, because the city is effectively promising to raise taxes in the future to meet its payment terms, if necessary.</p>
<p>The overwhelming majority (by dollar amount, certainly) of municipal bonds are sold through underwriters in firm-commitment underwritings. This means that a financial institution (a bank or investment bank, and most often for bigger issues a consortium of them) agrees to buy 100% of the bonds from the city when they are issued at a pre-negotiated discount, and to re-sell them to investors at the underwriter’s own risk. Usually, the underwriter assures the city (and the investors) that it will facilitate later sales and purchases of the bonds, since that will make the bonds more valuable to the initial investors and thus lower the city’s interest costs. So there’s usually no chance that the city will be unable to sell the whole bond issue; that only happens sometimes with very small or unusual issues.</p>
<p>The purchasers do not have to be citizens of the city itself, although in a city like NYC where the city income tax exemption is an important part of the bond pricing, they almost all will be. Generally, they will all be taxpaying citizens (or businesses) in the state where the city is located.</p>
<p>Bonds are usually issued for one of two broad purposes: to finance capital investments, or to anticipate revenues that are expected to come in over time (from taxes, collections of delinquent taxes, etc.). In the case of capital expenditures, a city is a lot like any other business. It wants to make a large, expensive investment that will pay back over time, either in increased tax or rental revenues, or in maintaining the revenues it has now. (If all the garbage trucks were 50 years old and broke down, so garbage wasn’t collected, you would see a decline in the city’s tax base, and long before that you would see the mayor lose an election.) To pay for that, the city has two choices – either it can set aside and build up a reserve fund out of its current revenues, until it has enough to pay for the investment, or it can borrow the money and pay back the loan with interest from future revenues. Given the well-known tendency of politicians to spend the cash available to them, borrowing is usually the more practical choice, if the city has the ability to borrow. It’s the same with any private business, except that private businesses are a little more likely to save money for projects, and they have a third option of selling stock or other equity interests to fund capital investment.</p>
<p>Repaying bonds doesn’t necessarily involve raising taxes. In fact, it would be very unusual for underwriters to underwrite a bond issue that could not comfortably be repaid without a tax rate increase or new tax, because then timely repayment of the bond would be awfully uncertain. They may (and do) accept what they consider to be conservative and prudent projections of increased tax revenues from growth, or more prosperity, or specific revenues from the project being funded, but not tax increases per se.</p>
<p>The percentage of city improvements that are bond-funded probably varies somewhat from city to city, but is likely to be somewhere between 90-100% (just my guess) for decently large cities that are not in dire financial trouble. And maybe even if they are: NYC went bankrupt in the 70s, and the state created a new entity to borrow money for municipal projects on a sound financial footing without getting involved in problems with the old bonds outstanding. That was preferable to having a complete collapse of local government in the state’s (and nation’s) most commercially important city.</p>
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