State Government Officials Riding Dirty

State government officials aren’t known for savvy moves, so when they apparently duped Wall Street out of billions of dollars from the tobacco settlement, it had to be a fluke.

True to form, states squandered the money, and now have little to show for their efforts. And as is always the case, we as taxpayers will be left to clean up the mess.

In 1998, 46 states reached a Master Settlement Agreement (MSA) with the four major tobacco companies in a lawsuit over health care costs. The four states that are not a part of the MSA reached settlements with the tobacco companies on their own.

All the lawsuits argued that tobacco companies knowingly produced a product that caused long-term health issues that would have to be paid for by states through their Medicaid systems.

The terms of the MSA called for tobacco companies to make payments to the states consistently based on the level of cigarette sales, with a minimum of $206 billion paid in the first 25 years.

Then things got interesting.

Smelling the blood of money in the water, the sharks of Wall Street began to circle. The stealthy predators approached governors, state comptrollers, and legislators and threw them some bait in the form of a question: “Why would you wait on the settlement dollars to be paid over many years, when you can get your hands on the money today?”

The state officials must have been thinking: “Money today, during my tenure, instead of many years in the future after I’m gone? That’s a great idea!” So the two parties — Wall Street and state officials — began the feeding frenzy of securitizing future payments from the tobacco settlement and selling them off to bond investors. Wall Street got its fees, and state officials borrowed money from the future to fill the coffers today.

But then something bad happened. Americans curbed their appetite for cigarettes and sales began to drop. While this definitely goes a long way toward solving the health-care issues related to smoking, it puts a serious dent in the flow of money that was to be received from the sale of cigarettes.

Suddenly, many of the bonds sold by states that are backed by payments from the MSA are looking shaky. It’s quite possible that there won’t be enough revenue to pay off the bonds. This might sound terrible, but there is a bright spot.

Most of these bonds are only backed by the tobacco payments, so if there is not enough money to repay, then bondholders eat the loss, not the states. It is in this relationship — where bondholders and not the states have the risk of loss from smaller payments — that government officials pulled a fast one on Wall Street.

If only they could have stopped there, everything would have been perfect… but it never happens that way.

Some of the money that was sucked out of the system was used on anti-smoking campaigns and educational programs, but the bulk of it was used for unrelated items.

Some states built schools with the money while others simply balanced their budgets, particularly during the financial crisis. The one glaring item that the states did not take care of was setting aside funds for increased Medicaid costs due to smoking.

To sum it up, the states won a huge financial victory from tobacco companies in order to pay for the health care of poor smokers in their old age, then teamed up with Wall Street to get as much money as possible in the door today, where they promptly spent most of it on everything but health care!

At this point, many states have exhausted all of their future receipts from the tobacco settlement. They’ve used the funds for unrelated items that should’ve been paid for with other funds — like taxes for general operating expenses, or bond issuances for schools.

If the states didn’t think they could’ve raised the taxes or sold the bonds, then they should’ve refrained from the spending.

In the future, when the cost of caring for elderly smokers falls on the states, they will look around for the money required to provide the care. Not finding any MSA dollars, they’ll look to that always handy source — taxpayers. Political expediency has once again cost us money, even if we haven’t received the bill yet.

As we go through the economic winter season, we keep finding reasons to lower our taxable footprint as much as possible. Seeing how states threw their money to the sharks and scrambled onto lifeboats, perhaps it’s wiser to keep yourself out of the water by choosing investments that minimize your tax bill.

Rodney

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About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.