them out there. Most of that is either in retail hands or in bond funds
that retail owns. This is likely to be a slow motion train wreck rather
than something that explodes into the headlines one morning. But it
will put a dent into some 401Ks. It already has.
By way of background on this let me diverge a bit and give you my side
of the tobacco story. I knew a fellow who was a mover and shaker in one
of the big US tobacco companies. Back in 1998 the tobacco companies
reached what appeared to be a very harsh settlement with the states. The
essence of that deal was that big tobacco would fork over a huge wad of
money and the states agreed not to sue for healthcare claims. At the
time the deal was inked I had a conversation with the guy. It went
something like this:
You have it totally wrong. This is a great deal for us. This is exactly
the deal that we hoped to achieve when we started this out. It looks
like we are big losers, but in fact, we are big winners.
That’s not what it says in the papers. They say you will have to fork
over ¼ trillion over the next few decades. How’s that such a good deal?
You have to understand, there was a real possibility that tobacco would
become a controlled substance. If that had been the case we would have
folded the tent in the USA. But with this settlement we are guaranteed to be in business forever, and we are shielded from liability. We made a pact with the devil. In this case, the State Treasurers are the devil.
don’t get it. Sure there is a new source of revenue for the states, but
there is also the increased medical cost that goes with it. Where’s the Beef?
This deal allows the states to securitize the future revenue from this
settlement. That means they can issue new bonds but they don’t have to
show it in their debt profile. The tobacco settlement is just a way for the states to get off balance sheet financing.
The guys on Wall Street are already ginning this up. The states can
issue billions of new bonds. The current crop of “Ins” will spend it. We used the State's greed to get what we wanted.
this is all going to blow up if the states do that! Ten – Fifteen years
from now this is all going to come due. What happens if they hock the
future settlement proceeds and then we find that there are no proceeds?
But I’m retiring in five years and those that inked this deal from the
states will be gone before the flameout. In the meantime, everyone is fat and happy.
Note: A lot of readers have said that I
dwell on the ‘dark side’. It’s true. Stories like this one are the
reason why. It’s not nice on the dark side. But when it comes to
politicians, money and Wall Street you’re safer with the dark view. You
don’t get surprised as much by what happens.
Back to June of 2011 and the cracks on all this are starting to appear, Some quotes from a recent Bond Buyer story:
The payments that cigarette manufacturers make to the states are dwindling as people smoke less, posing the latest setback to tobacco bonds.“We saw a consumption decline that was above and beyond our base-case expectation,” said Aoto Kenmochi, a tobacco bond analyst at Fitch Ratings.The precipitous
decline in payments threatens to leave some tobacco bonds outstanding
longer than expected. In the worst cases, the withering payments could eventually push some bonds into default.Fitch has downgraded dozens of tobacco deals as the fading settlement payments have left tobacco structures with less of a cushion to tolerate further erosions.
Here a few charts on some outstanding tobacco bonds. If you want a high
current yield this is for you. But beware; you may never get your
You can see from the pricing that these dogs have already been hit hard. More bad news is in front of these bonds.
The worst of the worst is the following. I have this on my Piece of S#*! list. Consider the insanity of this. Back in 2008 the State of Michigan borrowed $58 million.
They spent this money the very next day. This is a zero coupon bond so
Michigan doesn’t have to pay a penny until the maturity. The maturity was FIFTY YEARS!!!! The principal due at maturity? An unbelievable $4.4 BILLION. And there is not sufficient revenue to cover it. Note: This piece of crap is in pension fund hands. Talk about kicking a can down the road.