Question

Traverse County needs a new county government building that would cost \(10 million. The politicians feel that voters will not approve a municipal bond issue to fund the building because it would increase taxes. They opt to have a state bank issue \)10 million of tax-exempt securities to pay for the building construction. The county then will make yearly lease payments (of principal and interest) to repay the obligation. Unlike conventional municipal bonds, the lease payments are not binding obligations on the county and, therefore, require no voter approval.

Required

1.Do you think the actions of the politicians and the bankers in this situation are ethical?

2.In terms of risk, how do the tax-exempt securities used to pay for the building compare to a conventional municipal bond issued by Traverse County?

Short answer

(1) Yes, it is ethical.

(2) Tax exempt securities carries higher risk.

Step-by-step solution

Definition of tax-exempt securities 

Tax-exempt securities are those securities on which the borrower does not need to pay any tax.

Actions of politicians and bankers

Yes, the actions of the politicians and bankers in this situation are ethical because the process of funding is entirely transparent, and everyone knows about this. The second reason is that a yearly lease payment would not negatively impact the government. Hence, the actions of the politicians and bankers are ethical.

Level of risk

The tax-exempt securities have a higher risk than a conventional municipal bond issued by the county in terms of risk. Because in the tax-exempt securities, there is no regular source of income in the form of taxes, and it impacts the future creditworthiness negatively.