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So, why hasn't a single municipality or state (or government, for that matter) tried this approach?


Welcome to the Fool! I'm afraid that you've posted your question on a somewhat "dead" board - one that has had virtually no activity for quite some time. I still have it on my favorites and can pop in to answer this question, but in the future you might seek out one of the more active boards to post a question like this. I would suggest "Macro Economic Trends and Risks," which is an active board talking about economics:

Anyway, the reason that municipalities and states don't do this is because they would have to offer a much better yield on the bond than is typical of municipal bonds. The reason that investors are willing to loan their money to municipalities (by buying the bonds) at low rates is because those bonds are (usually) backed up with dedicated revenue streams or, in the case of general revenue bonds, the taxing authority of the municipal government. Depending on the financial situation of the governmental body, investors regard those assurances as providing much lower risk than investing in equities.

If the bonds are backed by nothing more than the municipalities bond portfolio, the investors instead bear all of the risk of investing in the stock market. They would therefore demand a high enough rate of return to warrant that risk - presumably something approximating the return they would expect if they just invested in that 'blue chip portfolio' themselves. The municipality isn't offering them a bond, but essentially a mutual fund.

If the bonds are backed by pledges of general revenue (either instead of or in addition to the portfolio), then the municipality is bearing that risk. They're basically just investing in the stock market on margin (though with a really good margin rate). You can make a lot of money doing that, but that's not a risk appropriate for municipal finances.

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