The adage that if something sounds too good to be true, it probably is, is being tested again by state and local governments that are being tempted by financial institutions with offers of easy money. Likely as not, the banks will get the easy money and the states and municipalities will be stuck with more debt.

Financial institutions are pushing pension obligation bonds, which are used to borrow money relatively cheaply to reinvest in pension funds, where the money can be put to work to fund retirements. The trick is that a change in the market such as the 2007-2009 crash could cause taxpayers to overpay interest on bonds with no guarantee the pension fund will remain stable.

“It’s sold as a magic bean,” Todd Ely, a professor at the University of Colorado Denver who has studied pension bonds, told reporters for ProPublica and The Washington Post who investigated the bonds. “But when it goes bad it’s not free. Then it isn’t really magic. If it could be counted on to work as often as it’s supposed to, then everyone would be doing it.”

The reporters found that states and municipalities had sold $670 million of pension obligation bonds in the first half of 2015. Even more will be sold in the second half, with Kansas planning a $1 billion sale.

Some of the enthusiasm for the bond issues comes from a rule change from the Governmental Accounting Standards Board (GASB). Pension funds on the brink of insolvency are required to use conservative projections for growth in their statements. But if the fund gets an infusion of money via a bond sale, it can return to using more optimistic growth projections, making it seem more solvent than it actually is.

The appearance of increased solvency can also cause governments to make smaller contributions to pension funds than they should.

“These bonds are pernicious,” Alicia Munnell, director of the Center for Retirement Research at Boston College, told ProPublica and the Post. “They discourage pension funding. They shift costs forward to future generations.”

The bankers, of course, make out either way. The report said that banks stand to make $3 million on Kansas’ proposed bond sale.

The Government Finance Officers Association (GFOA) has recommended that governments don’t issue the bonds. “I think that right now is probably as sketchy a time as any to get into pension bonds,” Dustin McDonald, who heads federal liaison efforts at GFOA, told the reporters. “You’re gambling with taxpayer dollars that in the end the investments you’re making are going to pan out for you. ... I just think it’s desperation that makes you make the decision.”

-Steve Straehley

To Learn More:

When Wall Street Offers Free Money, Watch Out (by Cezary Podkul, ProPublica, and Allan Sloan, Washington Post)

Mendocino County Follows Others in State Suing over Global Libor Bank Rate Scandal (by Ken Broder, AllGov California)

U.S. and New York Sue Mellon for Cheating Pension Funds out of Billions of Dollars (by Noel Brinkerhoff, AllGov)

Wall Street Bets on Cities and States Failing (by Noel Brinkerhoff and David Wallechinsky, AllGov)