Governor Malloy has been borrowing money – called “bond premiums” – to balance Connecticut’s state budget.
But what the heck are bond premiums?
On Black Friday, the CT Mirror’s Keith Phaneuf wrote an article entitled “Is Malloy poised to put much of the budget deficit on CT’s credit card?” The news story highlighted the fact that Governor Dannel Malloy has repeatedly used “bond premiums” to mask Connecticut’s debt and he appears to be poised to do so again.
As Phaneuf writes,
“Malloy relied heavily on bond premiums during his first three years in office, using more than $160 million to close budget deficits or to bolster the emergency reserve, commonly known as the Rainy Day Fund.”
And the article adds,
“According to records from the treasurer’s office, the state had taken $41 million in bond premiums through the first four months of the fiscal year.
The treasurer’s office said the state took another $37.7 million premium this week on $300 million in new bonds. That means more than $78 million has been added to the budget’s debt service line item since the fiscal year began.”
But explaining what “bond premiums” are is no easy feat.
So please stick with me here – what follows is an amateur’s effort to try to explain the maneuver in a way that makes some sense to those of us who are not accountants:
Imagine that Jack, Jill and Danny are three friends, fresh out of college and all making good incomes. [Maybe they got some of those lucrative UTC jobs thanks to Malloy’s corporate welfare program].
Jack, Jill and Danny each make $150,000 a year, each is carrying $50,000 in student loan debt (with an interest rate of 8%), each has immaculate credit, and each wants to borrow $500,000 so that they can buy matching side by side homes, thereby allowing them to car pool to work.
Together they go to the bank which is aptly named “The First and only Bank That Lends” and each one fills out the paperwork to borrow $500,000.
The bank, after reviewing their applications, immediately announces that it would be happy to lend them each $500,000 at 4% to be paid back over 25 years.
But the bank adds —- if they’d like, the bank will give them a $550,000 loan at 4.25% for 25 years thereby allowing each to have a $50,000 “premium” to spend on whatever they want.
Now Jack likes to keep things simple when it comes to financial matters and while the thought of taking the extra $50,000 is intriguing, he decides to keep his financial situation as clear as possible. Jack takes the $500,000 home loan at 4%, and decides to keep paying off his $50,000 student loan debt at the 8% rate.
At the end of 25 years Jack will have paid off his $500,000 home loan at 4% and his $50,000 student loan debt at 8%.
Jack will have paid a total of $907,527 in principal and interest.
Jill is more nimble when it comes to these financial things so she takes the $50,000 premium and pays off her student loans immediately, leaving her with a $550,000 home loan at 4.25%
At the end of 25 years Jill will have paid off her full $550,000 home loan at 4.25% (having used $50,000 to pay off her 8% student loan debt.)
Jill will have paid a total of $893,868 in principal and interest.
But Danny, who is aspires to a future in politics, loves to live for the moment. Danny decides to take the $550,000 loan at 4.25% but instead of using the extra money it to pay off his student loan he uses the “premium” to buy some things he has wanted to buy but couldn’t afford with his $150,000 income. Danny is therefore left with a $550,000 home loan at 4.25% and $50,000 in student debt at 8%
At the end of 25 years, Danny will have paid off the $550,000 loan at 4.25% and the $50,000 student loan debt at 8%
Danny will have paid a total of $1,009,640 in principal and interest.
In return for getting that $50,000 “premium” to cover his expanded expenses, Danny’s strategy means he will have paid $115,772 more than Jill and $102,113 more than Jack at the end of 25 years.
So now let’s return to the real world of Connecticut in 2014.
And lo and behold Governor Dannel Malloy’s fiscal strategy is exactly the same as Danny’s!
However, in the real world situation, the extra principal and interest is being paid for by the taxpayers of Connecticut.
So when you read Governor Malloy took $160 million in “Bond Premiums” to cover up the debt over the last three years and has taken another $78 million in “Bond Premiums” so far this year, we can remember that taxpayers are now on the hook for $238 million in additional principal which will mean far higher total costs in principal and interest payments then we would have otherwise incurred.
And perhaps even more importantly, DON’T FORGET that Connecticut taxpayers are now paying a higher interest rate on the underlying debt that Malloy borrowed so that he could get that “bond premium.” [Recall that Danny took the $550,000 home mortgage at $4.25% instead of 4% so he could get that extra $50,000 “premium” cash.]
Not sure that makes the bond premium issues any clearer, but here is a table that attempts to summarize the whole thing in a single chart…
|25 YEAR LOANS||JACK||JILL||DANNY|
|New House $500,000||4%||791,755|
|Student Loan $50,000||8%||115,772|
Bank Offers – $550,000 including a Bond Premium of $50,000
Jill uses her $50,000 to pay off student debt but Danny uses the $50,000 for expenses so still has his $50,000 in student loans at 8% interest rate
TOTAL over 25 years in principal and interest
Danny Pays $102,113 more than Jack
Danny pays $115,772 more than Jill
All to get the $50,000 “PREMIUM”