How Wall Street tobacco deals left states with billions in toxic debt

Politicians wanted upfront cash from a legal victory over Big Tobacco, and bankers happily obliged. The price? A handful of states promised to repay $64 billion on just $3 billion advanced


This story was co-published with Marketplace.

In November 1998, attorneys general from across the country sealed a historic deal with the tobacco industry to pay for the health care costs of smoking. Going forward, nearly every cigarette sold would provide money to the states, territories and other governments involved — more than $200 billion in just the first 25 years of a legal settlement that required payments to be made in perpetuity.

Then, Wall Street came knocking with an offer many state and local politicians found irresistible: Cash upfront for those governments willing to trade investors the right to some or all of their tobacco payments. State after state struck deals that critics derided as “payday loans” but proponents deemed only prudent. As designed, private investors — not the taxpayers — would take the hit if people smoked less and the tobacco money fell short.

Things haven’t exactly worked out as planned.

A ProPublica analysis of more than 100 tobacco deals since the settlement found that they are creating new fiscal headaches for states, driving some into bailouts or threatening to increase the cost of borrowing in the future.

One source of the pain is a little-known feature found in many of the deals: high-risk debt that squeezed out a few extra dollars for the governments but promised massive balloon payments, some in the billions, down the road.

These securities, called capital appreciation bonds, or CABs, have since turned toxic. They amount to only a $3 billion sliver of the approximately $36 billion in tobacco bonds outstanding, according to a review of bond documents and Thomson Reuters data. But the nine states, three territories, District of Columbia and several counties that issued them have promised a whopping $64 billion to pay them off.

Under the deals, the debts must be repaid with settlement money and not tax dollars. Still, taxpayers lose out when tobacco income that could be spent on other government services is diverted to paying off CABs. And states can’t simply walk away from the debt — bondholders have a right to further tobacco payments even after a default.

“It’s going to cost taxpayers, either directly or indirectly,” said Craig Johnson, an associate professor of public finance at Indiana University in Bloomington who has studied tobacco bonds and CABs. “I don’t doubt that at all.”

ProPublica’s analysis is the first to measure the magnitude of the high-risk debt involved in the tobacco deals and to calculate how much Wall Street’s dealmakers earned. It also shows how much of the tobacco money has been securitized — that is, turned into payments that go to investors. As of this year, at least one out of every three dollars coming in under the settlement is pledged to investors, according to bond disclosures and payment data from the National Association of Attorneys General, which tracks the flow of funds.

The sure winners so far: Investment bankers from Citigroup, the now defunct Bear Stearns and others who, along with consultants and lawyers, have pocketed more than $500 million in fees for their financial engineering, ProPublica estimates. They now stand to make more as the governments look to rework old deals and try to get even more tobacco cash upfront.

In part, the troubles in the tobacco bonds arise from the same kind of miscalculation that led to the housing bubble.

Just as mortgage lenders bet that home prices would keep rising, the tobacco deals relied on optimistic predictions of how much Americans would smoke. Forecasters rightly saw that cigarette sales would continue to decline, but now the yearly drop — about 3 to 3.5 percent — is nearly double what was cooked into the deals.

Because the bonds sold to investors can stretch 40 years or more, the outdated estimates mean an ever-widening gap between what states expected to collect under the settlement and the payments they promised investors.

The CABs promise gigantic payouts — as high as 76 times what’s borrowed — because nothing is due on them for decades. Meantime, interest compounds on both the principal and accumulating balance.

Defaults by state and local governments are rare, but rating agencies have been warning that tobacco bonds in general could go under en masse. Moody’s said in May that up to 80 percent of the tobacco issues it tracks are likely to default.

For CABs, defaults appear certain.

“They’re doomed,” said Jim Estes, a finance professor at the California State University, San Bernardino, who helped ProPublica analyze the bond documents. “It’s not a question of whether or not, it’s a question of when.”

Wall Street firms are already pitching their services to help unwind deals they helped create.

The first state to act was financially strapped New Jersey. In March, it rescued two CABs that were part of a larger 2007 deal. The CABs promised to repay $1.3 billion in 2041. To pay off that giant tab before it comes due, the state agreed to hand over $406 million of its remaining tobacco proceeds beginning in 2017, money that otherwise would have gone into state coffers.

Barclays handled the transaction for New Jersey and earned $4.5 million. The state also got $92 million in upfront cash out of the deal to help Gov. Chris Christie and lawmakers plug a budget deficit. Still, rating agencies weren’t impressed: They downgraded the state anyway, making it costlier for New Jersey to borrow.

In late July, Rhode Island announced a plan to buy out some holders of $197 million of CABs it sold in 2007. The deal would shave $700 million off a $2.8 billion tab due on the bonds in 2052 and let the state refinance some of its older tobacco bonds at more attractive interest rates. Now, some bondholders are suing to block the deal.

Most of the deals involving CABs sold right before the 2008 financial crisis, ProPublica found. As the horizon darkened, the market for them began falling apart, with one lone buyer keeping Wall Street’s CAB machine going. Pitch documents show that bankers pressed the states to act fast before the window shut.

“We are confident that we can stimulate demand,” Bear Stearns bankers told Ohio prior to a $5.5 billion tobacco bond package championed in 2007 by then state Treasurer Richard Cordray, who these days heads the U.S. Consumer Financial Protection Bureau.
Ohio’s tobacco deal was the largest ever. It included CABs that brought in $319 million in return for an eventual $6.6 billion balloon payment — a nickel on the dollar. Bear Stearns, Citigroup and other Wall Street firms made about $23 million in fees on the transaction, according to the bond offering document.

Then there is Puerto Rico, a government with a long history of financial woes.
In April 2008, as Bear Stearns was collapsing, it closed a $196 million tobacco bond sale that saddled the Puerto Rico Children’s Trust, a fund set up to benefit island families, with an eventual $8.6 billion balloon payout. Bear Stearns and Citigroup made $1.4 million in fees.

This year, Puerto Rico’s tobacco settlement receipts fell 13 percent below what was forecast when the deal was done. The commonwealth is also struggling to prevent default on a mountain of other debt. Officials there did not respond to written questions, phone calls or interview requests.

Critics have repeatedly lambasted the states and other jurisdictions for violating the intent of the tobacco settlement by spending the money on uses other than anti-smoking programs and health care.

“The securitization scheme not only accelerated the expiration of the usefulness of that money, but basically guaranteed that it would never be used for its conceived purpose,” said Dave Dobbins, an executive with the American Legacy Foundation, a non-profit created under the settlement to fund smoking-prevention programs.

“Now the money’s gone, the securitization scheme is sort of coming home to roost for some people … and the tobacco problem is still there: 480,000 people [are] expected to die this year due to tobacco-related disease,” Dobbins said.

“It’s a grim story.”

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Who is behind the CBI closure report in Satish Shetty murder case?

Sandeep Shetty alleges an invisible hand of a minister behind the filing of closure report in his brother and RTI activist Satish Shetty’s murder case. The case handled by CBI since last four years was coming to a near conclusion when all of a sudden the agency filed closure report


In a suspicious and strange turn of events, after four years of investigations the Central Bureau of Investigation (CBI), suddenly filed a closure report in the Satish Shetty murder case on 11th August. CBI investigations led to a 10,000 page report; several trips abroad by the investigative agencies and almost zeroing on 13 culprits, which were giving an indication about solving the murder case of the Right to Information (RTI) activist. The CBI spokesperson on Monday told the media that the closure has been filed at the Wadgaon-Maval court as it could not find sufficient evidence to prosecute the accused persons.

Just to recall, the 13 accused persons were named by slain RTI activist Satish Shetty in a land grab case along the Pune-Mumbai expressway through forging of documents, in a first information report (FIR) lodged by him at the Talegaon police station in October 2009. The names included the high profile owner of Ideal Road Builders (IRB), Virendra Mhaiskar, who is close to several top notch politicians of Maharashtra, as well as a sub-registrar and others. It has been alleged that the subsequent brutal murder of Shetty on 13 February 2010, was closely linked to his lodging of his FIR of October 2009. In fact, the CBI stuck to this FIR as the motive for Satish Shetty’s murder for a good four years, until as recently as 8 August 2014 and then suddenly changed course in the last three days.

The High Court had suo motu taken cognizance of Satish Shetty murder in 2010 and directed the CBI to probe it, which was otherwise being investigated by the Pune Rural Police. It had again, on 8th August, allowed the CBI to open up the land scam case in which, Shetty had lodged an FIR. In fact, CBI itself had made this requisition to the High Court, stating that it (the land scam) might be linked to the Satish Shetty murder and hence needs to be re-investigated. The High Court on 8th August, directed the agency to go ahead with the re-opening of the case and submit its report within four weeks. However, instead, the CBI submitted a closure report at Wadgaon–Maval court on the basis that there is no evidence against the 13 accused. All this in a matter of just three days, that is between 8th and 11th August 2014!

Moneylife spoke with Sandeep Shetty, brother of Satish Shetty who is doggedly pursuing the case to seek justice. Here are the excerpts from the interview...

Moneylife (ML): How do you react to CBI’s sudden closure of your brother, Satish Shetty’s murder case?

Sandeep Shetty (SS): It is very shocking that the CBI should have made a turnaround in three days flat. Where is justice left? Earlier, we thought the local police might be influenced by some higher-ups, but now the CBI too has bent backwards to please those in political power. It is impossible for the investigative agency to take action on its own, as the High Court has directed on 8th August that it should submit the report to it in four weeks time. Even if you say that suddenly no evidence was found, the CBI cannot file a closure report; it should have submitted such a report to the High Court. This is clear case of contempt of Court and hence the closure report is invalid. In fact, the Wadgaon-Maval court has no powers to accept the report, which needs to be submitted to the District Court that in turn has to call me for hearing before accepting the report. I am going to contest it (the CBI action) and it will indeed be the biggest scandal if the District Court accepts the closure report. I’m also going to Wadgaon-Maval Court today to get the copy of the closure report. I am also going to file a petition to the High Court to re-investigate the case. I would be talking to my lawyer for advice.

ML: You have directly alleged that the closure is a result of political clout. Why do you say so?

SS: That’s because the CBI has been investigating the case since the last four years and on 20 December 2013 it specifically told the High Court that Satish’s murder is directly related to the FIR Satish has lodged against Mhaiskar and others in 2009. Again, a few days back, on 8 August 2014, the CBI told the High Court that prima facie Satish’s FIR is the basic motive for his murder. This gave me hope that the case was on its way to getting solved and the culprits would be booked and punished as per Law. However, what else can one derive when in three days flat the CBI completely changed its stance and said that there is no circumstantial evidence against the accused, who were very much the accused until 8 August 2014.

We all know Nitin Gadkari’s links with the the Ideal Road Builders-IRB group of companies and it’s all in the public domain wherein IRB had loaned large amounts of money to Gadkari’s controversial Purti group of industries. Hence, I strongly feel that Gadkari’s pressure on the CBI resulted in the latter doing a complete u-turn unlawfully.  Would you believe that any government agency can do such a startling and brazen turnaround on its own, especially when it was sticking to its ground for a good four years?

(Vinita Deshmukh is consulting editor of Moneylife, an RTI activist and convener of the Pune Metro Jagruti Abhiyaan. She is the recipient of prestigious awards like the Statesman Award for Rural Reporting which she won twice in 1998 and 2005 and the Chameli Devi Jain award for outstanding media person for her investigation series on Dow Chemicals. She co-authored the book “To The Last Bullet - The Inspiring Story of A Braveheart - Ashok Kamte” with Vinita Kamte and is the author of “The Mighty Fall”.)



Praveen Sakhuja

3 years ago

It is on records of CBI and other investigating agencies that every murder related to disputes of any kind with one of the accuse being a politician or high profiled linked person with politicians cannot be solved independently until or unless government is interested in solving it. It is the links which turn the tables to side of that who has influential links as is said in this case naming Gadkari. I can only wish success, rest is left to GOD.

V. V. Vijayan.

3 years ago

Even after the induction of Mr.Rajan, RBI continues to be the very same sleeping giant, or monolith.It had issued a customer/public -friendly circular dated July 1, 2013, instructing all the banks to exchange forged currency notes across the counter, without harassing the tenderers. 14 months after its issuance, banks are refusing to implement the circular.I had a few months back brought this to the notice of Mr.Rajan. None, and nothing at the RBI has yet moved. Does Mr.Rajan know what is happening under his nose?

Praveen Sakhuja

3 years ago

it is not the CBI which killed the investigations motive, but time period played the role. After availing all luxuries CBI concluded the case for closure. As being said Gadkari is the email pivot around whom the plot revolves. Gadkari is in power as UPA ministers were why he will be implicated, when his people govern India with majority.


3 years ago

Who shot Cock Robin? Indeed. The story of India in microcosm. A sixty seven year old Saga where the Quota based Neta-Babu-Milard-VIP-Celebrity-Copocracy conspire against righteousness and probity:


3 years ago

Will NaMo take note of this case and take (proper) action? Will RSS ask for reopening and proper action?


3 years ago

Kudos to Moneylife and Vinita for such a brave stance in media ,exposure ,which is rare in these days of paid News.
Today only the P>M Modi asserted in Leh that he will be opposing bribe taking as well as giving. If in this case, no bribe is involved, it is equally a case of Influencing an investigation by the suspected persons wielding power at the top which is a part of corruption. Will P.M pl. act swiftly to retain a clean image of CBI in public eyes ?
The sincerity to fight corruption starts from self with NDA Government .


3 years ago

Bizzar CBI's report smells big fat Rat Who is manipulating -who is beneficiary sOMETIMES BACK pOORTY WAS RAIDED BY IT officials and Gadkari was furious and roared saying let BJP come to Power Rest is history Gadkari's nexus with IRB and Sanchetis -Adarsh fame known to all IRB's TOLL scandal was revealed by MNS chief.It's time Prashant Bhushan of AAP take the brief and expose CBI Is it working for IRB ?

Sudhir Jatar

3 years ago

An excellent write-up and I fully agree with Vinita'a conclusions

Govt introduces Bill to repeal 36 obsolete laws

The Amendment Acts, which are sought to be repealed, include amendments to the Representation of the People Act, Marriage Act, Election Laws, Divorce Laws and Anand Marriage Act, and the Evidence Act


Seeking to clear the statute books of antiquated laws, the Union Government on Monday introduced a Bill in the Lok Sabha, to repeal 36 Acts, including one which amended marriage laws.


Law Minister Ravi Shankar Prasad introduced the Repealing and Amending Bill, 2014, which seeks to remove certain Amendment Acts and Principal Acts from the statute books as they have outlived their utility.


This is the first time since 2001 that such an exercise is being undertaken by the Law Ministry.


Through the Bill, the Government also seeks to amend a ‘patent error’ committed by the Law Ministry during the passage of the Whistleblowers Bill.


While the Bill became an Act in May this year, it is called the ‘Whistleblowers Protection Act, 2011’ instead of '2014’.


The Bill makes it clear that once the measure becomes an Act, it will not affect any other law in force.


The Amendment Acts, which are sought to be repealed include amendments to the Representation of the People Act, Marriage Act, Election Laws, Divorce Laws and Anand Marriage Act and the Evidence Act.


Two standalone Acts which will also be repealed through the Bill are the Foreign Jurisdiction Act, 1947, and Sugar Undertaking (Taking Over of Management) Act.


“The Bill is one of those periodical measures by which enactments which have ceased to be in force or have become obsolete or the retention whereof as separate Act is unnecessary are repealed or by which the formal defects detected in enactments are corrected,” said the Statement of Objects and Reasons of the bill.


The decision is in tune with Prime Minister Narendra Modi’s agenda to do away with archaic laws which are hindering efficient governance.


After this, the Government is likely to move another bill to repeal more such Acts in the next session of Parliament. Between 1950 and 2001, over a hundred Acts have been repealed. In one instance, 100 such Acts were repealed in one go.


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