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Fronting the Debt Has Serious Implications

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By Lowell L. Kalapa

You would think that taking advantage of the current low interest rates to refinance existing debt is a great strategy to saving a great deal of money not only for a homeowner but in this case state and county governments.
And for homeowners it is a great idea in that mortgage payments are a lot smaller because the interest rate is lower. In the case of the homeowner, the monthly mortgage payment is recalculated at the time of the refinancing and at least some of the principal, the amount borrowed, is paid with each monthly payment. At first, the amount of principal is minuscule by comparison to the amount of interest that is due. However, as more of the principal is paid, the amount of interest paid every month declines over the term of the mortgage note.
Such is not the case with respect to the public debt of the state and counties. Bonds issued by the state and county governments in Hawaii are required to pay only the interest portion of the debt service payment for the first three years after the issuance of the bonds. This allows the state or county government to pay the bare minimum on the borrowed debt as it begins to process the use of the money in moving a capital improvement project forward such as the planning and design costs before ground is even broken to build a facility.
However, when government refinances existing debt, that is bonds that were issued sometime ago for a project that may already be completed, it does so not only to take advantage of the lower interest rate, but also to free up cash resources to pay for current programs. That wouldn’t be such a bad move except no provision is made to set aside some of that newly found cash to pay for the principal on the refinanced debt.
Instead, both state and county governments have used the cash that has been freed-up by the refinancing to pay for new or expanded programs or in some cases just to keep government operating. Such is the case with the state as it has struggled to balance the state general fund budget for the past ten years. In the case of the counties, it has allowed officials to avoid raising property taxes or in some cases actually being able to lower property tax rates as assessments rise.
In the latter case, property taxpayers breathe a sigh of relief because their property tax bills don’t rise and in the case of the state, lawmakers can proudly say that they balanced the budget because they were able to use the cost savings from the refinancing to pay for current services. This hedonistic euphoria can last for only so long. As both state and county governments refinance about all the existing debt, the Armageddon is just around the corner as the three-year honeymoon comes to an end.
Within the next year or two, the refinanced debt will require that both principal and interest be paid. If tax revenues continue to show modest growth, will both the state and county governments have the resources to pay the substantial hike in debt service payments?
At the county level, each county is struggling either to provide tax relief to real property taxpayers as assessments rise dramatically or in some cases finding other sources of income to pay for programs. At the state level, resources to fund general fund programs are already insufficient as lawmakers continue to raid special funds to pay for those programs.
If the economy does not improve to the point where it is producing tax revenues far in excess of the projected growth of general fund expenditures, either taxes will have to be increased or lawmakers will be forced to actually cut spending on all other programs. Inasmuch as the state and counties have pledged the full faith and credit of their resources to the repayment of their debt, debt service payments must be made before any other program or project can be funded. To do otherwise would cause the state or county to default on its debt, an action that would ruin the credit rating of that government entity for a very long time.
As noted above, there is nothing wrong with state or county governments refinancing their debt to take advantage of the historic low interest rates. However, the prudent corollary would be to set a part of the savings aside to pay the principal on that debt as it comes due. Refinancing has the effect of taking principal that would have been paid off in the next few years and stretching that cost out over the next twenty or thirty years.
In the meantime, state and county governments will continue to issue debt, but at more than likely higher interest rates. The debt load will grow at the expense of all other operating programs and possibly at the cost of a tax increase.

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