Applause for ‘Mature’ Debt Reform, but More Needed

Good policy isn’t always controversial. House Bill 24, which was signed into law on July 2, caused no floor theatrics, mass tweeting, or activist howls. The bill, proposed by Rep. John Lawrence (Chester County) and passed unanimously in both houses, saved taxpayers millions of dollars in debt interest costs with nary a comment from anyone. Lawmakers deserve more praise for this than they got. The new law is a small improvement, but more extensive reforms to commonwealth borrowing practices would save billions of dollars more.

The new law changes the allowable maturity profile for commonwealth general obligation bonds, that is, the schedule on which the state must pay back its borrowings. Bonds are simply packages of certificates sold to investors and repaid with interest. From now on, new bonds will have to be repayable in equal regular amounts of principal (level principal) rather than in small amounts of principal early followed by larger amounts of principal later (level total payments, like a standard home mortgage). 

The law will cause the commonwealth to pay back its debts faster, and thus pay less interest. Under a level principal schedule, the state would pay $17 million less on a $500 million loan (assuming 4% interest and a 20 year maturity) than it would have under a level payment schedule. Republican lawmakers suggested the law would have saved more than $1 billion had it been in place in the past. 

Level principal was actually the law until 2001, when the Capital Facilities Debt Enabling Act was changed to allow back-loaded principal payments. Pushing principal repayment into the future allows for smaller payments in the early years and thus eases difficult near-term budget choices. However, it costs taxpayers considerably more over the life of the loan.

Lawmakers deserve praise for once again prohibiting back-loaded principal payments. However, the law still has some considerable weaknesses.

The law only applies to new bonds. The near-term impact of the law will be limited because it only applies to new debt. States do tend to call, or refinance, their debts from time to time, but even then the impact of the law will be limited, because refinancings are not subject to the level principal repayment law. Through opportunitstic refinancing, then, the state can circumvent the law.

The law can probably be circumvented. Bankers have plenty of tricks to help their clients borrow as much as possible. The capitalization of interest (adding it to the principal balance under special bond terms) or the use of additional contracts like swaps might offer ways for the state to keep delaying principal repayment.

Most state debt isn't general obligation debt. Only a fraction of Pennsylvania government bonds are actually borrowed explicitly on the credit of the commonwealth. Most debt is owed by government-related entities like the Turnpike or the Commonwealth Financing Authority. As shown in the chart, any reform that applies to general obligation bonds alone can only ever be a partial reform.

The most important major reform to supplement HB 24 would be to extend the new maturity rules to all state entities that have borrowing authority. In the longer term, the number of borrowing entities should be streamlined and consolidated and debt reporting should be improved, simplified, and made more timely.  Ultimately, the best way for the commonwealth to save money on interest is to borrow less, but in the meantime it can at least increase transparency by making the debt easier to count. 


Graph: Most State Debts Are Outside the General Fund