How Wall Street Tobacco Deals Left States With Billions in Toxic Debt

I don't understand how the states are losing on those deals.

As designed, private investors — not the taxpayers — would take the hit if people smoked less and the tobacco money fell short.

Then why are the states supposedly settled with the debt resulting from the forecasts being too optimistic? Was the 500 million dollars worth of financial engineering botched so badly that it failed to achieve its primary goal?

Also,

Under the deals, the debts must be repaid with settlement money and not tax dollars.

which to me means that the states at worst lose this unusual source of revenue from the settlement. A source that is drying up faster than predicted. This should not lead a state into bankruptcy or defaulting on other obligations.

It seems that Cordray was right

“Five years from now, 10 years from now, smoking bans are kicking in, taxes may change, maybe court decisions. If the tobacco companies are not profitable, Ohio would be out its money. But if we cash in now, we will have our money and we will shed the risk,” Cordray was quoted saying in a July 2007 report by The Associated Press.

and he thinks he was right

Cordray told ProPublica the state made the right decision. The decline in tobacco payments means they were riskier than believed, he said, and CABs helped the state maximize its proceeds. If payments decline further, he said, investors should pay the price, not Ohio.

“Obviously, they are always going to want to come back, cup in hand, saying to the state, ‘Put some money in it,’” Cordray said. “But it’s not necessary; it’s not legally required and in fact was the whole purpose of this deal.”

Private investors are taking the hit, selling the debt at pennies on the dollar to hedge funds, while states get to keep the money they made by selling those capital appreciation bonds in the first place. Whether it was wise to turn nice steady revenue flow into a one time payment is another question but, as sbmassey notes, you can't really expect democratic politicians not to.

An investigative piece from ProPublica into the piecemeal securitization of the 1998 tobacco settlement revenue, and the increasing toxicity of the ensuing debt. States essentially sold out their future revenue stream, and committed to paying more back out in order to plug short-term budgetary holes. These obligations extend for decades, and have ballooned into the billions of dollars, dwarfing what the actual payouts would have been. It is unlikely that these bonds will ever be repaid to the agreed upon terms.

The securities in question are Capital Appreciation Bonds (CABs).

That map they have in the article is pretty much worthless since it's not weighted by state population. It pretty much resembles a population map.

the main problem is putting democratically elected politicians in charge of state finances - of course they are going to get as large an immediate payout as possible, and not worry about the long term consequences: that is exactly what you would expect from someone on a four year election cycle.