In the realm of municipal finance, bonds are issued by governmental entities to fund public projects. Among these, two significant types of bonds are the Moral Obligation Bond and the General Obligation Bond. Understanding the distinctions and implications of these bonds is crucial for investors, municipal finance officers, and policymakers.
Definition of Moral Obligation Bond
What is a Moral Obligation Bond?
A Moral Obligation Bond is a type of municipal bond that relies on a non-legally binding commitment from the issuing government entity to provide additional financial support if necessary. These bonds include a “moral” pledge of support, but they do not legally compel the issuer to use taxpayer funds to back the bond if project revenues fall short.
Definition of General Obligation Bond
What is a General Obligation Bond?
A General Obligation Bond (GO Bond) is a municipal bond backed by the full faith and credit of the issuing government entity. These bonds carry the strongest form of security, as they legally obligate the issuer to use its taxing power to ensure repayment of both interest and principal. This can include property taxes or other forms of revenue.
Key Differences
Security and Backing
Moral Obligation Bond
- Backed by a non-binding moral pledge.
- Relies on revenues from the project financed.
- Issuer may seek legislative appropriation to cover shortfalls, but this is not guaranteed.
General Obligation Bond
- Backed by the full faith and credit of the issuer.
- Legally obligates the issuer to use taxing power for repayment.
- Considered a lower-risk investment due to strong backing.
Legal Implications and Risk
Moral Obligation Bond
- No legal obligation to use taxpayer funds.
- Higher risk for investors if project revenues fail.
- Lower credit rating compared to GO Bonds.
General Obligation Bond
- Legal commitment ensures repayment.
- Lower risk for investors.
- Generally higher credit rating, resulting in lower interest rates.
Use Cases and Examples
Moral Obligation Bond Examples
Moral Obligation Bonds are typically used for projects where the issuing entity prefers not to fully commit its taxing power, often for revenue-generating projects like toll roads, sports facilities, or convention centers.
General Obligation Bond Examples
GO Bonds are commonly used to finance essential public infrastructure such as schools, highways, and sewer systems, where the issuer is confident in the project’s essential nature and its ability to justify the use of taxpayer funds.
Historical Context
Evolution of Municipal Bonds
The concept of municipal bonds has evolved to meet the diverse funding needs of public projects. General Obligation Bonds have long been the backbone of public finance, offering reliable security for essential services. Moral Obligation Bonds emerged as a flexible alternative, allowing municipalities to undertake ambitious projects without overextending their fiscal commitments.
Applicability in Modern Finance
Both types of bonds remain relevant in contemporary public finance. Cities and states continue to leverage General Obligation Bonds for critical infrastructure, while Moral Obligation Bonds provide pathways for innovative, revenue-generating projects that enhance community development without immediate taxpayer burden.
Related Terms
- Revenue Bond: A bond secured by specific revenue sources, typically from the project financed.
- Tax-Exempt Bond: A municipal bond whose interest payments are exempt from federal, and sometimes state and local, income taxes.
Frequently Asked Questions
What are the benefits of investing in General Obligation Bonds?
GO Bonds offer investors lower risk due to the strong backing of the issuing government entity’s full faith and credit, often resulting in better credit ratings and lower interest rates.
Why might a municipality choose to issue Moral Obligation Bonds?
Municipalities may issue Moral Obligation Bonds to finance projects expected to generate revenue, without fully committing taxpayer funds, providing flexibility and innovation in funding.
References
- “Municipal Bonds: The Basics”, Securities Industry and Financial Markets Association (SIFMA).
- “Understanding Municipal Securities”, Municipal Securities Rulemaking Board (MSRB).
- “Public Finance and Investment Banking”, Kaufman, G. and Edwards, R.
Summary
Moral Obligation Bonds and General Obligation Bonds serve distinct purposes in municipal finance. Understanding their differences—particularly in terms of security, legal commitment, and use cases—helps investors and issuers alike navigate the complexities of public project funding. While GO Bonds provide robust security with legal guarantees, Moral Obligation Bonds offer flexibility and innovative financing solutions with an element of risk.
