The Fed to study economic bubbles

The Wall Street Journal (5/16, A1, Lahart) reports that the Federal Reserve, the nation's chief bubble watching agency, has hand-picked a "band of young scholars" in Princeton University to study economic bubbles. The journal notes that the importance of understanding bubbles -- how they start, how they evolve, and how they deflate -- has been evident by "the damage done by the housing and credit bubbles."

So far, the study group has concluded "that the Fed can and should try to restrain bubbles, rather than following former Chairman Alan Greenspan's approach" of "watchful waiting while prices rise, and then cleaning up the mess after a bubble bursts.

David Walker's new positions

With the title of "America's Prophet of Fiscal Doom,"U.S.News (04/11, Pethokoukis) reports an interview with David Walker, who resigned from the high-profile position of U.S. comptroller general, GAO, on March 12th to head the Peter G. Peterson Foundation. Walker explains his leaving for the belief that "we have a closing window of opportunity to make changes in order to avoid a major crisis" and thus he aims to lead the foundation "address key sustainability challenges that threaten the future of Americans."

Laterly, FedSmith.com (04/24) reports that Walker joints the Partnership for Public Service, which has a mission is "to revitalize our federal government by inspiring a new generation to serve and by transforming the way government works."In welcoming Walker to the board, Max Stier, president of the Partnership said: "David Walker represents public service at its best. He's intelligent, tenacious, honest and 100 percent committed to doing right by the American people. I know he will do great things in his new position as the head of the Peter Peterson Foundation, and I am proud to welcome him to the Partnership's board."

Bond interests, bond yields, and the yield curve

A municipal bond issued by a government is an agreement that the government will pay back certain amount of long-term debt to investors on a specific (maturity) date.

Interests of bonds are reflected either explicitly by coupons when bonds are sold by their par values, or implicitly by the difference between par values and their discounted selling prices. Bond interests constitute the major cost of borrowing for a bond issue, but there are additional costs for the issuer (government) including the payments for professional services by bond counsels, financial advisers, or underwriters.

The yield of a municipal bond is the rate of return an investor will receive by holding the bond to maturity. It is determined based on the actual market value of a bond rather than its par value. For instance, the "current yield" of a bond calculates the percentage return that the annual coupon payment provides the investor based on the the price the investor pays for the bond (See the following equation from Investopedia).

Although a bond may carry a fixed coupon interest rate over its term, its actual bond yield fluctuates with that of all other bonds currently offered in the market and have similar credit quality and maturity.

The yield curve is the relation between the bond yield and the time to maturity of the bond. The yield on the Y axis is often, but not always, an increasing function of t on the X axis. (See the figure above from wiki.)

The timing of school bond referendum

According to Minneapolis Star-Tribune (1/2, Relerford), "The Orono School District's $39.4 million bond referendum scheduled for Feb. 12 has sparked controversy among residents in recent weeks because of the timing and amount of the request."

Orono officials said the additional money they are seeking would pay for interior and exterior improvements at several schools. If the referendums are approved, the bond will be paid back by increased property tax over the next 20 years. An owner of a $300,000 home would need to pay additional about $125 a year.

It is not easy for residents to buy in such ideas. In November 2005, a proposed $31 million bond in the district for similar upgrades was rejected by voters. The following November, Orono district residents approved a $500,000-a-year operating levy that saved 11 teaching positions. In this year, while Orono was still preparing its proposal, neighboring districts of Westonka and Delano had weighed in on levy and bond referendums on Nov. 6. Westonka voters approving an operating levy while Delano voters rejected two of three spending proposals.

Interestingly, during the 2005 referendum, levy opponents in Orono hired an Iowa-based consultant who has helped some nearby communities defeat several proposals of levy extension or increased expenditure. It is unclear whether residents get help from outside experts this time, but their suspicion of timing seem to be justified by empirical studies -- it has been found that a referendum has a higher chance to be passed if the voter turnout is low. With a concern that many of their neighbors will be out of town in early February or could forget to request absentee ballots, some residents are afraid that school officials may pick the unusual timing as "an attempt to sneak it."

Big hit on the municipal bond market

Local governments with low or no credit ratings may purchase bond insurance to pull up their ratings and thus save borrowing cost. However, the Los Angeles Times (12/20) reports that "[b]illions of dollars of municipal bonds insured by ACA Financial Guaranty Corp. were cut to 'junk' status Wednesday after Standard & Poor's downgraded the insurer itself because of its exposure to losses on mortgage-backed debt." The firm's rating went to CCC from A, which already "was the lowest rating among bond insurers."

For municipalities that had provided their own ratings to shield bonds insured by ACA, the S&P took the step only of cutting the bond's rating "to match those of the municipality." However, "[r]atings on other ACA-insured bonds fell to CCC to match ACA's rating."

For these public entities, the downgrade may not affect borrowing cost of the debt really issued, and some officials claim that there "wouldn't be any major impact on cities' ability to issue more debt" as well, just that they will "look to obtain insurance from another bond insurer next time it seeks to issue more debt."

Nevertheless, as Bloomberg (12/19, Quint, Cooke) reported, the involvement of municipal bond issues in the spreading credit crisis meant, "Wall Street's three-year love affair with debt sold by U.S. states and cities is over."

Minnesota State's Budget Volatility

Jay Kiedrowski: Let's Stop the State's Fiscal Roller Coaster

In this editorial Jay writes about the volatility of state finance in Minnesota. Last November there was an announced forecast surplus of $2.2 billion by June 2009; no the number has turned to a forecast deficit of $374 million. Due to Minnesota's volatile revenue structure -- more to know about from my perspective -- the state budget condition can be big disappointments during economic slowdowns and recessions, or happy surprises during economic recoveries and accelerations. As high level of uncertainty raises the difficulty of budgeting and financial management, there is a bipartisan consensus to reduce revenue volatility, in which taxes/expenditure do not have to raised to cut.

Wayzata Public Schools receives bond rating upgrade

Wayzata Public Schools receives bond rating upgrade

Today I came across this report, which can be a good case for my advanced financial management course. Minnesota School Districts provide a potential context to extend my previous co-authored paper about education performance's impact on school bond ratings, especially for the fact that there is much variation in bond ratings here. The reasons are still unknown -- maybe there is no state-guaranteed program like that in Texas?

Education data in Minnesota are available through the MN/DOE's website (Thank you, Owen.)

Data sources for financial benchmarking

1. For state and local governments:
• Data from Census Bureau
  
• Data from Government Finance Officers Association
  
• Data from International City-Manager Association
• Data portal by Carl Vinson Institute of Government
  
• Data from National Center for Education Statistics
2. For nonprofit organizations:
• Data from National Center for Charitable Statistics
  
• Data from GuideStar
  

Florida State Investment Trust Fund in Trouble

• Fund Crisis In Florida Worrisome to States
• Florida Towns and Schools Pull Back Troubled Investment Fund
  

Like many other state governments, Florida pools money from state agencies and local governments into funds in an attempt to earn higher returns. Because of concern over investments linked to subprime mortgages, Florida’s local governments in recent weeks have withdrawn billions of dollars from the fund. In response, top Florida officials moved on Nov. 29 to stabilize an investment pool by temporarily suspending withdrawals by cities and school districts. The turmoil has left some towns and school districts unable to meet payrolls or pay bills and has raised concerns about similar funds across the country.

The freeze was lifted days ago but Florida schools and towns continued to pull out funds even with penalties. The withdrawals suggested state officials have yet to restore confidence in an investment fund that was the largest of its kind in the United States at $27 billion before schools and cities pulled almost half their deposits last month.
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p.s. Click here for the news report by the Economists.

Own Source Revenues: What to include?

In calculating budget solvency of local governments one common index is the own-source ratio: to what extent a government is relying on revenues that are generated from its own source rather than intergovernmental transfers, which in general are associated with a high level of uncertainty.

The question from many students is where to look for own-source revenues or what to include. These are my suggestions:

In the Statement of Activities, you will see program revenues, program expenses, and general revenues. Most general revenues are own-source ones expect for items that are called "grants" or "transfers." Things can be more complicated for program revenues, because some of the local services (such as health care) are funded by higher levels of governments, and so part of program revenues that are associated would be intergovernmental in nature.

A better idea is to look for information elsewhere in the financial report or in the budget. Ideally the government would report it somewhere clearly how much it has received from other governments during the fiscal year. These transfers are mostly from the federal government or the state government as general-revenue sharing or restricted grants, but there may also be revenues form other local governments, for instance, due to interlocal service contracts.

"Marketable Securities" in cash solvency analysis

What should be included as "marketable securities" in cash solvency analysis? This is a common question from many of my students in PA5003.

According to "Investopedia," marketable securities are very liquid securities that can be converted into cash quickly at a reasonable price. They tend to have maturities of less than one year. Examples include "commercial paper, Treasury bills and other money market instruments." [Jerry: note that money market account may be considered as "cash equivalent."]

For an "unknown" fund of investment in a financial statement, try the following steps:

1. See whether it is listed under "current" or "noncurrent" assets -- it is a marketable security if listed as a current asset;

2. Try to search around (in the file or on Internet) or contact financial specialist in the government (organization) to know what is the fund about and how it is operated;

3. If you still cannot determine, take the conservative route and treat it as noncurrent and not include it as a marketable security