Monday, December 29, 2008

Tobacco Settlement Turned Upside Down

“Tobacco bonds” link state budgets to cigarette sales.

Bob Sullivan of MSNBC reports that ten years after a group of states wrestled Big Tobacco to its knees in a $200 billion settlement, the creation of “tobacco bonds” by Wall Street has allowed investors and state governments to borrow against their future tobacco settlement payments. The result? Money that was to be paid out over the next thirty years for smoking cessation programs is being redirected into infrastructure projects and shoring up municipal credit.

“A review of 660 leading bond funds covered by the investment research firm Morningstar Inc., conducted at’s request, showed that more than 260 are invested in tobacco bonds,” Sullivan writes on his blog, The Red Tape Chronicles.

What, you may well ask, are tobacco bonds, and where did they come from? “Perhaps from you,” Sullivan writes. “When Wall Street talked 25 states into borrowing against future tobacco payments—a process known as ‘securitization’—it sold bonds to individual investors and mutual funds that buy municipal bonds.”

The irony of that approach, says Sullivan, is that “because these states have essentially borrowed against future payments from the tobacco industry, they are now dependent on the continued vitality of cigarette sales. If Big Tobacco stumbles, states will be on the hook for these massive, billion-dollar loans.” As a lawyer involved in litigation over the tobacco settlement put it to Sullivan: “Now [the states] have an incentive not to put tobacco out of business.” More than that, any significant failure by the tobacco industry to make its payments would be “catastrophic both to state budgets and individual investors.”

It wasn’t supposed to be this way. But the settlement from the lawsuit designed to blow up Big Tobacco was just too attractive to investment bankers. Sullivan notes that Oppenheimer’s Rochester family of bond funds includes funds with up to 20 per cent of assets held in tobacco bonds. The lure to the states was that, rather than waiting for the money, they could opt for an attractive lump sum payment up front. And many states did just that.

The problem, according to a tobacco policy researcher quoted on Sullivan’s blog, is that “the states have this horribly naive view that they will outsmart Wall Street. Wall Street always gets the better deal.” Many states have settled for a payout of 50 cents on the dollar, plus additional insurance fees against the risk of tobacco companies going out of business.

Eric Lindblom, a director of the Campaign for Tobacco-Free Kids, told Sullivan: “There is a horrible failure of the states to invest even a minuscule amount of the funds for tobacco control. It’s a real tragedy for our country.”

Roughly 3 per cent of tobacco settlement money has been paid out for smoking cessation efforts over the decade since the settlement, Sullivan writes.

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