Question

politicians feel that voters will not approve a municipal bond issue to fund the building because it would increase taxes. They opt to have a state bank issue $10 million of tax-exempt securities to pay for the building construction. The county then will make yearly lease payments (of principal and interest) to repay the obligation. Unlike conventional municipal bonds, the lease payments are not binding obligations on the county and, therefore, require no voter approval.

Required

1. Do you think the actions of the politicians and the bankers in this situation are ethical?
2. In terms of risk, how do the tax-exempt securities used to pay for the building compared to a conventional municipal bond issued by Traverse County?

Answer 1

I think that the actions of the politicians and the bankers in this situation are ethical. This is because the actions, first of all, do not lack transparency. Secondly the payment of yearly lease will not have a negative impact on the government general funds as the lease in not binding in nature. The truth about the deal is being made known to everyone and hence the actions are ethical. Thus as long as transparency is maintained and there is a justified need with no known adverse impact then the actions of the politicians and the bankers in this situation will be ethical.

In terms of risk it is the tax-exempt securities used to pay for the building that bears greater risk when compared to conventional municipal bond issued by Traverse County. This is because in case of the tax-exempt securities there are no binding obligations on the county. Also there will be no direct source of revenue in the form of taxes for tax-exempt securities and this will increase the quantum of risk. The future credit worthiness can also be negatively impacted.