What are General Obligation Bonds?

Published by Thomas Herold in Economics, Investments, Laws & Regulations

'General Obligation Bonds' is explained in detail and with examples in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

General Obligation Bonds are municipal bonds which are reinforced by the full taxing powers and overall credit worthiness of the jurisdiction which issues them instead of a certain revenue stream from the associated specific project. These special general types of bonds are floated by municipalities under the belief that the jurisdiction will have the resources in the future to pay back all of its debts via general taxation or incoming revenue from other projects. With these GO bonds, there is no collateral from other underlying assets of the issuer.

What makes these general obligation bonds so appealing to investors even though they have no underlying security behind them is that the issuing government agency has promised to utilize every available resource, including tax revenues, in order to pay back the bond holders. Such pledges from local governments can include a promise to assess special property taxes so that the government entity is able to meet its obligations to the bond holders. As an example, property owners have skin in the game because of their local area property holdings and any unpaid property tax obligations.

Credit ratings agencies will analyze and rate the pledges of general obligations according to the strength of their credit qualities. They then assign them generally high investment graded ratings. When said property owners are incapable of paying in their fare share of property taxes according to the final due date, the government is permitted legally to raise the effective rates of property taxes in order to compensate for any delinquencies. On these required due dates, a general obligation bond pledge will mandate that the local government entity has to pay its owed debt using the resources which are available.

These general obligation bonds are also useful for the local area governments to be able to raise sufficient funds for needed projects which will build up revenue streams for projects including bridges and roads, equipment, and parks. Such bonds are generally utilized to pay for government infrastructure projects which will serve the general good of the public at large.

It is actually the relevant state laws which set the stage for what local governments are allowed to issue in the forms of these general obligation bonds. They can be unlimited tax obligation pledges or limited tax obligation promises to repay. Unlimited tax obligations are much like the limited tax promises. The principal difference pertains to the local government being required to raise property tax rates to levels that will service the debts, even as high as 100%, in order to cover other taxpayer delinquencies. It is up to the local residents to agree in advance to property tax increases which are needed to repay the bonds.

Alternatively the limited tax obligation pledges request that the local government issuing the bonds will increase the property taxes as needed in order to cover the debt service obligations. There is a statutory limit that provides boundaries for these. Governments are able to employ a portion of the property taxes which are already levied, increase existing property tax rates to a level that will service the debt payments, or utilize an alternative revenue stream in order to pay the debts as required by the terms of the general obligation bonds.

Such general obligation bonds are usually considered to be the safest form of municipal bonds because they are backed up by the ability of the issuer to tax. There are also other reasons that give them their aura of perceived safety. Companies may go bankrupt every day of the year, but municipalities can not.

They have therefore a far greater motivation to maintain their precious credit ratings since they can not simply go bankrupt and disappear into oblivion. They will also have to return to the bond markets periodically at other points in the future so that they can fund still more projects for their constituents. Besides this, the state laws generally detail the precise conditions under which the issuing municipalities are able to issue such general obligation bonds, as well as the kind of security they are able to utilize.

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The term 'General Obligation Bonds' is included in the Economics edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.