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The Danger in Using Bank Loans to Fund Infrastructure

The vast majority of bank-financed public projects remain a mystery to municipal bond investors, taxpayers and securities regulators.

May 17, 2016

Did you know that there is no federal transparency required when the government turns to retail bank loans for infrastructure construction?

This is how traditional public works funding goes:

  • Step One - State and local governments set public works projects
  • Step Two - Investment bankers create and supply financial products such as municipal bonds to spread the construction costs over the lifetime of the project
  • Step Three - Investors buy those financial products, usually in the form of municipal bonds. All the terms and extent of those bonds are made public from the very start.
  • Step Four - Taxpayer dollars repay the bonds.

Now, here's the problem: On some public projects, Step Two is changing.

A new funding model is gaining acceptance where a community may borrow money as a direct loan from retail bank to build a public project. This alternative funding model has reached more than $155 billion a year and continues to grow.

The terms and extent of those direct bank loans are secret. There are no disclosure requirements for the state/municipality/community to make public the terms of those direct bank loans.

In other words, investors who buy municipal bonds that are based on direct retail bank loans have no idea if the project owners, such as a city, has taken on more debt than it can handle. Those investors also don't know if the banking making the loan has a contractual agreement that it will be first in line to be repaid if the city finds itself in financial trouble. And trouble can come from many sources.

It happened in Lawrence, Wisconsin and bondholders got burned.

Read more of Lynnette Kelly's story here at Governing.com

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