I think tobacco bonds are headed into the crapper. There’s about $56b of 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.
Tobacco bonds are either in retail hands or in bond funds that retail owns
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 cigarette 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:
Bruce Krasting: Man you guys took it in the ear on this one. Good-bye dividends, goodbye profits. You guys got smoked!
Lucky Strike: 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.
Bruce Krasting: Huh? 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?
Lucky Strike: 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.
Lucky Strike Packs
Bruce Krasting: I 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?
Lucky Strike: 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.
Bruce Krasting: But 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?
Lucky Strike: If that were to happen it all goes Boom. 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.
Bruce Krasting: Oh. So that’s how things work.
