Pension Obligation Bonds: Financial Crisis Exposes Risks

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State and local government officials face a perfect storm of problems: On one hand, the sharp decline in equity markets has resulted in a large increase in underfunded liabilities among state and local pensions. On the other, the recession has cut into state and local tax revenues, limiting the ability of governments to make up these shortfalls.

Pension obligation bonds (POBs), which are a general obligation of the government, can alleviate pressure on a government’s cash position and may offer cost savings. While the use of POBs is controversial, some still see an important role for them in the future, especially after the global financial crisis. This brief evaluates POBs’ viability as pension financing instruments. Key findings include:

  • Some state and local governments issue POBs to raise cash to cover their required pension contributions.
  • POBs allow governments to avoid increasing taxes in bad times and could reduce pension costs, but they pose considerable risks.
  • Those who issue POBs are often fiscally stressed and not well-positioned to handle the investment risk.
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