What it means
When a government borrows, the bond documents say where repayment will come from. A full faith and credit obligation is backed by the issuer's general taxing power and overall financial strength, not just by the income of a particular toll road or water plant.
That makes it a stronger claim than a bond tied only to one stream of revenue. In the United States, debt issued by the federal government carries this backing, which is a large part of why Treasury securities are used as the reference point for a risk-free rate.
State and local governments also issue general obligation bonds backed by their taxing power, although the strength of that backing depends on each issuer's finances and the legal limits on its taxes. The phrase therefore describes the form of the promise, not a guarantee of safety in every case.
For a finance professional, the phrase explains why bond yields differ. A government bond backed by full faith and credit usually pays a lower interest rate than a corporate bond or a revenue bond, because investors accept less return in exchange for stronger security.
The gap between the two yields is the extra reward for taking on more risk. The concept also appears in guarantees.
When a government agency says that its guarantee carries the full faith and credit of the government, lenders can treat the loan as being close to government debt. Some agencies and government-sponsored entities do not carry that explicit backing, and investors have to read the wording to find out.
An important nuance is that the pledge is a promise, not a magic shield. A government that borrows too much, or that faces political disputes about its debt limit, can still see its credit rating questioned.
Strong backing lowers risk, but it does not remove it.
In practice
Real-world examples.
Example
A corporate treasurer has $5,000,000 of surplus cash that she cannot afford to risk for the next six months. She puts it into short-dated government securities because the repayment promise is backed by the full faith and credit of the federal government. She accepts a lower yield than a bank deposit or corporate paper would offer.
Example
A city issues general obligation bonds to build a new school. Because the bonds are backed by the full faith and credit of the city, including its power to levy property taxes, they carry a lower interest rate than bonds backed only by a stadium's ticket sales. The finance department saves interest every year of the bond's life.
Example
A lender makes a loan to a small business that is guaranteed by a government agency with explicit full faith and credit backing. If the borrower fails, the lender can claim on the guarantee instead of absorbing the whole loss. That security allows the lender to offer a lower rate and longer term than it would otherwise.
Case study
Seen in the real world.
Maplewood is a fictional town used to illustrate how this backing works. It planned to raise $12,000,000, and its finance officer compared two options: a general obligation bond backed by the town's full faith and credit, and a revenue bond tied to the income from a new car park.
Investors saw the general obligation bond as the safer one, because the town could raise taxes if needed to meet payments. The revenue bond would depend on how many drivers actually used the car park, which no one could be sure of. In this illustrative comparison, the general obligation bond priced at a noticeably lower interest rate.
The council chose the general obligation bond for the main project but had to commit to staying within its debt limit. The illustrative lesson is that a stronger promise lowers borrowing costs, but it also ties the whole town to the debt.
Watch out
Common mistakes.
- Assuming every government-linked bond has full faith and credit backing, when many agencies and government-sponsored entities carry only an implied or limited backing.
- Treating full faith and credit as a guarantee of zero risk, when interest rate changes, inflation and credit rating shifts can still move the bond's price.
- Thinking the phrase applies only to national governments, when states, cities and school districts also use it in general obligation bonds.
Questions
People also ask.
Why do bonds with this backing pay lower interest?
Investors regard the repayment as safer, so they accept a lower return in exchange for that security.
What is the difference between a general obligation bond and a revenue bond?
A general obligation bond relies on the issuer's taxing power, while a revenue bond relies only on income from a specific project.
Can a government with full faith and credit debt still default?
In principle yes, because the promise is only as strong as the government's ability and willingness to pay, although national governments that borrow in their own currency rarely do so.
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