Refinancing State and Local Debt

Abstract

Government budget cuts have been commonplace in state and local governments for most of the last seven years. One way state and local governments can cope with these cuts is to reduce the amount they must pay for the interest and principle on their financial obligations, including what they have borrowed or what they anticipate with good reason having to pay. If state and local governments were not cashstrapped, they could attempt to pay off such obligations or where permissible they could use reserves to create investment funds to pay them. Nevertheless, state and local governments that wish to reduce debt service pressure on the budget can refinance their financial obligations in such a way as to reduce or better manage the recurring interest and other costs. Cutting debt service to help absorb revenue cuts can be an appealing avenue for helping to restructure state and municipal operating budgets and the funds that these budgets comprise. It should be done when necessary, but always with caution, because ultimately it diverts money from capital to operating needs. One cost reduction approach is to refinance direct debt such as bonds or other securities that a state or municipality has previously sold on the market. This refinancing is carried out by using the various financial instruments for borrowing money by issuing public debt. When refinancing leads to lower current periodic payments, it reduces the recurring annual amounts paid to honor existing debt obligations and reduces the cash flow necessary for debt service in the government budget. The idea is to reduce the amount that state or local governments must pay in annual interest for these obligations—even if they may pay it for a longer period—thus reducing pressure on the budget. Borrowing is used to change the original terms of debt repayment in such a way that present costs are reduced even if net present value may be decreased. Consequently, it is an acceptable trade-off to pay less today when financial pressures are greater and more in the future when increased revenue is anticipated. The cost of extending debt buys reduced budgetary pressure. Another way financial measures can help state or local governments survive falling revenues is by using them to reduce or smooth the