Municipal bonds, commonly known as “munis,” are debt securities issued by local governments—states, cities, counties, and other public entities. These bonds serve as a crucial financial tool for municipalities to meet their ongoing financial obligations and to fund essential public projects. Think of projects like building new schools, constructing highways, or upgrading essential infrastructure like sewer systems. When you invest in municipal bonds, you are essentially lending money to these government bodies. In return, you receive a promise of regular interest payments, typically twice a year, along with the return of your initial investment, or principal, at a future date known as the maturity date. A municipal bond’s maturity can range from a short term of one to three years to long-term durations exceeding ten years.
Municipalities issue bonds for a variety of compelling reasons, primarily centered around funding public projects and services without relying solely on current tax revenues. Issuing bonds allows municipalities to finance large-scale, long-term capital improvements that benefit the community over many years. Instead of raising taxes significantly in a single year to pay for a new school, for example, a municipality can issue bonds to distribute the cost over the bond’s lifespan. This approach makes these large projects more financially manageable and equitable for taxpayers.
There are two primary types of municipal bonds that explain why municipalities choose different financing routes:
General Obligation Bonds
General obligation (GO) bonds are typically issued by states, cities, or counties. These bonds are not secured by any specific assets but are instead backed by the “full faith and credit” of the issuing municipality. This “full faith and credit” pledge signifies the issuer’s commitment to use all available resources, including its power to tax residents, to repay bondholders. GO bonds are generally used for projects that benefit the entire community and are funded through the municipality’s general revenue streams, primarily taxes.
Revenue Bonds
Revenue bonds, in contrast to GO bonds, are not backed by the municipality’s taxing power. Instead, they are secured by the revenues generated from a specific project or source. Examples include bonds issued to finance toll highways, where the revenue to repay bondholders comes from toll collections, or bonds for lease-financed projects, repaid through lease fees. Some revenue bonds are classified as “non-recourse,” which means that if the designated revenue stream fails to generate sufficient funds, bondholders do not have a claim on other municipal revenues. The risk in revenue bonds is thus more directly tied to the success of the specific project they finance.
Beyond these main categories, municipalities sometimes facilitate bond issuance for private entities, often non-profit organizations like universities or hospitals, through “conduit” bonds. In these arrangements, the non-profit borrower is responsible for repaying the municipality, which in turn pays the bondholders. Crucially, in most conduit bond agreements, the municipality is not obligated to repay bondholders if the private entity defaults.
The issuance of municipal bonds is a cornerstone of public finance, enabling local governments to invest in infrastructure and services that enhance the quality of life for residents. The tax-exempt nature of municipal bond interest, particularly at the federal level and sometimes at the state and local levels, makes them attractive to investors seeking steady, tax-advantaged income. For municipalities, issuing bonds provides access to capital at a lower cost compared to taxable debt, further explaining why this financing method is so widely utilized for public benefit.
