How Stockton got snookered

Just as the economy was beginning to tank in 2007, the city sold $125 million worth of bonds in order to close a shortfall in its pension plans. The bond sale was underwritten by Lehman Brothers, which, according to a finance professor looking over the paperwork, understated the risk. He believes that Stockton, now in bankruptcy protection, is entitled to some relief. Other municipalities fell into a similar trap. From the NYT:

The basic premise of all pension obligation bonds is that a municipality can borrow at a lower rate of interest than the rate its pension fund assumes its assets will earn on average over the long term. Critics contend that municipalities that try this are in essence borrowing money and betting it on the stock market, through their pension funds. The interest on pension obligation bonds is not tax-exempt for this reason. Alicia H. Munnell, director of the Center for Retirement Research at Boston College, looked at outcomes for nearly 3,000 pension obligation bonds issued from 1986 to 2009 and found that most were in the red. "Only those bonds issued a very long time ago and those issued during dramatic stock downturns have produced a positive return," Ms. Munnell wrote with colleagues Thad Calabrese, Ashby Monk and Jean-Pierre Aubry. "All others are in the red." Only one in five of the pension obligation bonds issued since 1992 has matured, so the results could change in the future.