Another State Fraud Unwinding (Tobacco Bonds)
Nothing like a good racket, eh?
A handful of bonds backed by yearly payments from tobacco companies under a landmark settlement with 46 states are in the earliest stages of default, and more distress is expected.
Dozens of states, counties and cities issued the bonds to receive billions of dollars upfront from the 1998 settlement. But now they are seeing smaller payments than expected from the companies as tobacco sales decline in America. There is also a renewed legal battle between the states and the tobacco companies, with the companies holding back nearly $8 billion in settlement payments, pending resolution.
Nice.
What happened here is that the states “sold forward” the cash flow from the tobacco settlement predicated on smoking continuing to increase in prevalence while at the same time raising taxes and taking other actions to deter smoking.
The states and other agencies use “projections” from an “independent consulting firm” to look at expected payments over 40 years, then set the bond terms on that projection. But…
“Those were all bogus,” Mr. Larkin said. “Yet the consultants used that report year after year.”
I seem to recall that ridiculously-rosy (and ultimately proved bogus) “projections” of a similar nature that house prices would go up 10% a year forever were part and parcel of the offering of securities backed by subprime and Option ARM mortgages, both of which were effectively balloon notes as nobody could make the payments once the “teaser” features expired.
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