Explaining state bonds

On Monday, Gov. Neil Abercrombie announced a discrepancy between the state budget bill and the bond authorization bill – a $444 million mistake.

But what does that all mean?

Here’s a guide to bonds.

What exactly is a bond?

Simply put, a bond is an IOU, or a debt that is issued by states and cities to finance various projects.

When a person buys a bond, they are like a bank that is lending to a borrower, such as the government. An investor will loan money with the promise that it will be paid back.

For example, cities may sell bonds in order to raise money to finance new infrastructure, such as a bridge or highway. There are pre-determined times during the year when the issuer will make payments on the principle and interest payments.

Investors are sometimes attracted to bonds because they can be safer than the stock market, due to the regularity of the interest payments, and the relative size and permanence of governments.

What’s the difference between a revenue bond and a general obligation bond?

A revenue bond is financially backed by the revenue that is created by the project being financed. For example, a revenue bond issued to finance the building of housing projects, bridges, football stadiums, etc., will be paid back by the income generated by the project.

In contrast, a general obligation bond is backed by the full faith and credit of the issuer, meaning it is guaranteed to be paid back because the government or city can use any means necessary to make its payments. It can use any source of funding, including raising taxes. This type of bond is generally considered low-risk for investors because of this.

So what happened with the state budget?

Just days before the 2014 legislative session closed, the state agreed to purchase lands in Kuilima, on the North Shore of Oahu, to keep those lands from being developed by Turtle Bay Resort. This purchase required a last-minute change to the state budget, according to House Finance Chair Sylvia Luke, which led to the error.

David Louie, the state attorney general, noted that the governor would not have legally been able to sign the budget bill in its current form.

The Department of Budget and Finance found that the appropriation of funding to the state educational facilities improvement (SEFI) fund was the main area of discrepancy; the projects accounted for in the budget bill exceeded the amount in the bond declaration bill.

To resolve the issue, the general obligation bonds appropriation to the SEFI project will be reduced by about $45 million to make the budget bill and the bond declaration bill balanced in time for July 1, the start of the new fiscal year.

Got more questions about bonds? Let us know in the comments!