What is Yield Burning?
Yield burning is a term that describes the process of pricing a Treasury bond in order to generate an artificially lower yield. Yield burning results in municipalities paying inflated prices for government securities used in refinancing more expensive older debt. Sometimes, the older debt cannot immediately be retired. This is because, due to restrictive provisions, certain municipal bonds cannot be replaced immediately and may only be called, or refunded, at a later date. In these cases, municipalities sell new debt and invest the escrowed proceeds of that debt in U.S. Treasury securities while waiting to retire the older debt legally. Special escrow accounts comprised of Treasury securities and other government bonds are created that give state and local governments the ability to wait until their bonds can be called and then replace the old debt with the escrow fund. Federal law prohibits municipalities from earning more interest on the Treasury securities than that which they are r
Yield burning is a practice that has long been held to be unethical and eventually was declared illegal. The procedure for yield burning involved placing inflated markups on bonds that were used to complete some forms of municipal bond offerings. This action of marking up the price of the bonds would cause the yield to fall, creating a situation referred to as a burn. The idea behind the use of yield burning was to get around certain aspects of United States federal law that have to do with the amount of interest income that a municipality could earn on Treasury securities. Under the terms and conditions of the issue of the securities, the municipality is prohibited from making more money in interest than is paid on the debt. By engaging in bond markups, it is possible for the underwriter for the bond to still realize additional revenue from the project without impacting the interest earned from the bond. When it was still possible to use yield burning as a way to circumvent securities
