The bonds were created in the aftermath of the huge legal settlement made between tobacco companies and US states in 1998, which means the tobacco industry pays compensation to states across the country for nearly every cigarette that is sold.
Securitizations of these compensation payments might give municipal governments a short term fiscal buzz, but the long term implications on their financial health — and the social and moral cost that the bonds imply — are drastic.
Compensation payments are calculated based on cigarette sale volumes. To structure the securitization, states estimate consumption levels for the life of the deal in order to calculate how much they can borrow from investors.
This creates a perverse situation whereby if smoking declines faster than expected — a social good — municipal budgets would be threatened by creating a gap between the compensation owed by the major tobacco companies, and the coupons owed to bondholders.
It is darkly ironic to think that state balance sheets might actually be bolstered by a growth in cigarette consumption. It also creates a huge conflict of interest for local authorities, who should be working to improve the health of their residents without fearing the financial side effects of doing so.
Some forms of financial engineering are healthy. But it has been misused in this instance. Given the progress made in social impact and sustainable financing methods in recent years, there should be better ways of putting this compensation cash to work.
It is time for banks to create some financial nicotine patches and drop the tobacco ABS habit for good.