Wonky Word Wednesdays: Bonding

Jan 21, 2015

By MBPC Staff

This week Governor Bullock’s infrastructure bill, called the Build Montana Act (HB5), had a hearing in the Joint Appropriations Sub-Committee on Long-Range Planning. Part of this bill proposes to spend nearly $400 million to build and improve infrastructure projects across Montana. Some of the projects include funding for new university buildings and support to communities in Eastern Montana. His proposal aims to finance about half of the costs for these projects through bonding to the Montanan public. With this bill in mind, I thought that bonding would be a great wonky word for the week. So what exactly does it mean to finance through bonding? Rather than using tax dollars (cash) or drawing down a budget surplus, states and local governments can finance large capital projects by issuing bonds to the public. For the borrower (state and local governments), bonding is an effective way to quickly raise funds, spread-out expenditures across long-term infrastructure projects that typically have high up-front costs, and take advantage of low interest rates. On the lender’s side (you and me), we benefit by participating in a very safe investment and are able to create intergenerational equity (a wonky word in itself) since we all now technically “own” some share of an infrastructure project. Not to mention, we’re supporting the schools, roads, bridges, and other public works projects that make our economy flourish. Need an example? Let’s take a look at a simple case to understand bonding better. A bill passed to fund a $5 million road in Montana. The state doesn’t have enough revenue or surplus from the last budget to pay this project outright. So it decides to finance by issuing 5,000 bonds to the public, each at a cost of $1,000. The road will be completed in one year, at which time the government must pay back its debt to the public, including interest owed. Depending on the borrowing length of the project and the amount that the government will have to pay back at the end of this term, interests rates can range between 3% and 8%. Since, $5 million is a lot to pay back in one year, we’ll assume there will be a lower interest rate set at 2% to lessen the state’s burden. If I (as a citizen) buy a $1,000 bond this year from my local bank or TreasuryDirect, I will receive $1,020 next year. This includes my initial $1,000 loan and 2% interest. While I’m not rich off of this investment, it’s a sure-fire way to accrue some additional savings and has the added bonus of investing in my state. Depending on the bond amount, interest rates, and borrowing period, the investment could yield more. Not to mention the government has now raised the $5 million needed to build the road. So bonding is one way for governments to finance much needed infrastructure that help us all. Communities need safe bridges and roads, and we all benefit from schools that provide an educated workforce. Keep checking our blog and our Facebook page for updates throughout the session on variety of issues and bills that we follow.