Definition
A moral obligation bond is a type of tax-exempt bond issued by a municipality or a state financial intermediary, which is backed by a non-binding commitment from a state government to provide support if needed. These bonds are primarily used to finance public projects and offer a cushion of additional security to investors through the state’s moral obligation, although the commitment is not legally enforceable.
Examples
Infrastructure Development: Suppose a state issues moral obligation bonds to fund the construction of a new highway. If the revenues generated from tolls and vehicle registrations fall short of the amount needed to repay bondholders, the state may choose to cover the shortfall, based on its moral obligation pledge.
Public Housing Projects: A city might use moral obligation bonds to finance an affordable housing project. Should the project face financial difficulties and be unable to meet its bond obligations, the state can step in to offer additional support, although it is not legally required to do so.
Frequently Asked Questions
Q1: What is the key characteristic that distinguishes moral obligation bonds from other municipal bonds?
- The distinguishing characteristic is that the backing from the state comes in the form of a moral obligation rather than a legally binding commitment.
Q2: Are moral obligation bonds considered safe investments?
- While they do offer an additional layer of security through the state’s moral obligation, they are not as secure as bonds with a full faith and credit backing, as the state’s pledge does not carry legal enforceability.
Q3: Can moral obligation bonds default?
- Yes, since the state’s pledge is not legally binding, there is a risk of default if the municipality or issuing agency cannot meet the payment obligations, and the state decides not to appropriate funds.
Q4: How do credit rating agencies view moral obligation bonds?
- Credit rating agencies often rate moral obligation bonds higher than standard municipal bonds due to the additional pledge of state support, but lower than bonds with a full faith and credit pledge.
Q5: Why would a state choose to issue a moral obligation bond?
- States might choose to issue moral obligation bonds to support local projects indirectly without committing to a legally binding financial liability, thus preserving their credit and maintaining budget flexibility.
Related Terms
Tax-Exempt Bonds: Bonds that are not subject to federal income tax, and often state and local taxes, making them attractive to investors looking for tax-advantaged returns.
Municipal Bonds: Bonds issued by local governments, municipalities, or their agencies to finance public projects, often offering tax-exempt interest income.
Full Faith and Credit Bonds: Bonds that are backed by the full taxing power and creditworthiness of the issuing government entity, making them among the safest types of municipal bonds.
Revenue Bonds: Bonds that are repaid from the revenue generated by the specific project or source funded by the bonds, rather than general tax revenues.
Online References
Suggested Books for Further Studies
- “The Fundamentals of Municipal Bonds” by The Bond Market Association
- “Investing in Municipal Bonds: How to Balance Risk and Reward for Success in Today’s Bond Market” by Philip Fisher
- “The Handbook of Municipal Bonds” by Sylvan G. Feldstein and Frank J. Fabozzi
Fundamentals of Moral Obligation Bonds: Public Finance Basics Quiz
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