The basics

General obligation (G.O.) bonds are a common type of municipal bond. They fund important projects for a city, state, or local area that don’t generate enough revenue to pay for themselves. These are called non-self-supporting projects, and they include schools, roads, parks, and government buildings. A non-self-supporting project is one that does not produce the revenue needed to cover its own costs.

When a G.O. bond is issued, the municipal government borrows money from investors and repays it over time. Because the project itself doesn’t generate the cash to repay the debt, the municipality uses taxes to make the bond payments. Specifically, G.O. bonds are typically repaid with property taxes.

Each year, property owners receive a tax bill from their local government based on the value and type of property they own. Property taxes, also called ad valorem taxes, support many public services, including school districts, police departments, park maintenance, and city libraries. When a municipality wants to fund a new non-self-supporting project, it can raise money by issuing G.O. bonds, pay for the project, and then use property tax collections to repay investors over time.

G.O. bonds are typically not backed by specific collateral. Instead, they’re backed by the full faith, credit, and taxing power of the municipality. Full faith and credit bonds are generally not as safe as secured bonds, but a municipality’s taxing power is an important source of support. If a state or local government doesn’t have enough funds to make required payments on a G.O. bond, it may be able to raise property taxes with voter approval.

Even so, raising taxes isn’t always a complete solution. A municipality’s ability to repay G.O. bonds can also be affected by factors such as population growth, economic diversity, and other municipal obligations. For example, the city of Detroit filed for bankruptcy in 2013, which is still the largest municipal bankruptcy filing in US history. Contributing factors included a declining population, reliance on a single dominant industry (the auto industry), and significant pension obligations.

When a municipality’s population declines, the local government loses taxpayers. This is one reason local officials try to attract residents and businesses: more people and businesses generally mean a larger tax base.

Relying heavily on a single industry can also create risk. Detroit grew around the automobile industry. When the industry expanded, it supported a booming local economy with stable jobs and strong wages.

By the time of the Great Recession of 2008, conditions had changed. The economy experienced the largest financial collapse since the Great Depression in the 1920s and 1930s. During economic downturns, consumers often delay purchases of durable goods such as automobiles.

Auto sales plunged in 2008 and 2009, creating major problems for Detroit. Because so much of the city’s economy depended on the auto industry, business closures and layoffs affected large portions of the population. Over the following years, many residents left Detroit to find opportunities elsewhere, which further reduced the city’s tax base.

Municipalities can also face pressure from large long-term obligations, such as pensions. Pensions are retirement plans that are generally offered by government entities today. If your job provided a retirement pension, you would receive an ongoing benefit after retirement, typically for life. Many pension plans require at least 20 years of service to qualify. Once the requirements are met, the employer typically pays a set percentage of the worker’s earnings (for example, 80% of the worker’s highest year of earnings) throughout retirement.

Pensions provide long-term income for retirees, but they can be costly for employers. An organization that offers pensions is responsible for making payments over a retiree’s lifetime, even during financial stress. So, if a municipality experiences serious financial problems, it still must make pension payments. When Detroit faced financial challenges in the late 2000s and early 2010s, pension payouts added to the strain.

In summary, G.O. bonds help state and local governments fund important projects that don’t generate their own revenue. Repayment depends on the municipality’s ability to collect enough property taxes to meet its debt obligations. Other factors - such as population trends, economic concentration, and pension obligations - can weaken that ability. We’ll discuss analyzing general obligation bonds in further detail later in this unit.