How California governments borrow money

Infrastructure is expensive…

All the municipal services we take for granted require a lot of expensive infrastructure. To give just one example, the city of Manteca in San Joaquin County is experiencing a population boom and needs to raise $623 million to upgrade its water and wastewater systems.

Do you need a new fire station? Millions. Do you need a new school? Millions more. Once built, they need to be upgraded every 15 to 20 years and replaced every 40 to 50 years.

…So governments borrow to pay for infrastructure.

When counties, municipalities and districts responsible for schools, fire protection and municipal water systems need to raise these millions of dollars, they borrow them in the form of municipal bonds.

A municipal bond is a “debt security” sold to institutional and retail investors who receive periodic interest payments until maturity and then have their principal repaid. Investor income from bond payments is generally tax-free because it provides bondholders with an incentive to invest.

The two most common types of municipal bonds are:

• General obligation bonds that are not secured by real estate collateral that can be foreclosed on, such as: B. Home loan. Instead, they rely on the “full trust and credit” of the community and its ability to raise funds through taxes
• Revenue bonds backed by revenue from a specific project or source, e.g. B. Fees on water bills to pay for a wastewater treatment plant

In California, bonds in elections must be approved by two-thirds of the voters in the jurisdiction in which the bonds are to be issued.

Proposition 5, on the November 2024 ballot, aims to reduce voter approval to 55% for various project categories, such as the construction of affordable housing, hospitals, police stations and parks.

California voters approved Proposition 39 back in 2000, which lowered the hurdle needed to pass school bonds from a two-thirds majority to 55%.

The limit of a government agency’s total borrowing capacity is set in different ways. My hometown, the City of Santa Cruz, “is authorized to issue general obligation bonds pursuant to Section 1418 of the City Charter, subject to a limit not to exceed the sum of 15% of the total assessed property value for city tax purposes.”

The California Constitution (Proposition 13) sets the property tax rate at 1 percent and “also permits the addition to the 1 percent tax rate of a rate necessary to pay interest and repayment costs on voter-approved debts.” Detailed bond notices appear on property tax statements along with the direct telephone number for the relevant government district so that a taxpayer can receive answers if they have questions.

The creditworthiness of bond issuers is determined by third-party rating services. In general, the higher the rating of a bond, the lower the bond yield. Lower-rated bond issuers often have to offer bonds with higher yields to entice investors to buy riskier bonds.

Borrowing money to pay other obligations

While we’re focusing here on using bonds to finance the costs of building infrastructure, in some cases they can also be used to finance other costs. One example is the Pension Obligation Bond, which is used to borrow money at low interest rates to finance higher-yielding investments, thereby covering the unfunded portions of a state’s employee pension liabilities. It’s a risky game, and the Government Finance Officers Association flatly warns state and local governments against it.

Pension liabilities are a growing problem in California, with combined state, county and local pension liabilities estimated at about $250 billion in 2024. Unfunded pension obligations are a problem here in Santa Cruz County, as several municipalities have issued pension obligation bonds over the past 20 years.

California’s skyrocketing debt

Every year, new bond measures are available to voters on state and local ballots.

The current total state and local debt is approximately $1.6 trillion. As California faces rising costs due to extreme weather and wildfires caused by the climate crisis, these are only increasing as repayments become a larger and larger share of future annual revenues.

In the meantime, everyone in Manteca must keep their taps running and their toilets flushed.