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The impact of the pandemic and the Fed’s muni program on Illinois muni yields
We estimate a simple model in which variations in Illinois daily municipal bond yields are explained by high-frequency indicators summarizing economic and public health conditions in Illinois, as well as key changes in the Federal Reserve’s Municipal Liquidity Facility (or MLF). We find that the MLF appears to have reduced Illinois muni yields by more than 200 basis points.
Working Paper
The “Privatization” of Municipal Debt
We study the determinants of local governments’ reliance on bank loans using granular data from the Federal Reserve. Governments that are larger, rely on stable revenue sources, or have higher spending relative to revenues are more likely to borrow from banks. About a third of governments in the top revenue quintile have obtained bank loans since 2011, typically accounting for a fifth of their total debt. Declines in revenues, reductions in bond market access, agency rating downgrades, and relationships with financial advisers and underwriters all strongly predict higher bank loan reliance. ...
Working Paper
Flight to Liquidity or Safety? Recent Evidence from the Municipal Bond Market
We examine the effects of the COVID-19 pandemic and subsequent monetary and fiscal policy actions on municipal bond market pricing. Using high-frequency trading data, we estimate key policy events at the peak of the crisis by focusing on a sample of bonds within a narrow window before and after each policy event. We find that policy interventions, in particular those with explicit credit backstops, were effective in alleviating municipal bond market stress. Next, we exploit daily variation in traded municipal bonds and virus exposure across U.S. counties. We find a shift in how bond investors ...
Working Paper
Financial Innovations and Issuer Sophistication in Municipal Securities Markets
When local governments default or file for bankruptcy, it is often because public officials misunderstood the risks associated with innovative financial products. If unsophisticated municipal bond issuers were to widely adopt a high risk financial product, this could harm taxpayers and investors, as well as destabilize the financial system. This analysis uses municipal bond issuers? total debt outstanding as a proxy for their sophistication and investigates the relationship between sophistication and adoption of financial innovations. Using comprehensive data on securities issued between 1992 ...
Working Paper
The Impact of Covid-19 Related Policy Responses on Municipal Debt Markets
Municipal (muni) bonds are an important source of funding for state and local governments. During the Covid-19 pandemic, muni debt markets became severely distressed. In response, the Federal Reserve established the Municipal Liquidity Facility (MLF). Meanwhile, Congress enacted extensive fiscal measures that included direct aid to cities and states. To understand whether and how these policies worked, we employ a state-level regression model to estimate the relative efficacy of monetary and fiscal policy interventions for the term structure of muni-Treasury yield spreads. We find that fiscal ...
Report
COVID Response: The Municipal Liquidity Facility
At the onset of the COVID-19 pandemic, state and local governments were among the sectors expected to experience the most severe distress. The combination of a sharply deteriorating revenue picture, a pressing need for additional expenditures, delays in the receipt of substantial taxes owed, and an inability to access the financial markets raised serious concerns among many observers about the ability of state and local governments to meet their public service delivery responsibilities. In April 2020, the Federal Reserve announced the establishment of the Municipal Liquidity Facility (MLF) to ...
Working Paper
Sovereign Default in the US
In the absence of a judicial mechanism to reduce the debt burden of a sovereign member of our Union, the resolution process can be quick but perhaps too indifferent to the health, safety, and welfare of the affected residents. In this paper, I use evidence from the Arkansas state archives to provide a description of the events surrounding the default of the state in 1933. I examine the evolution of the negotiations, the outcomes, and the role of fiscal policy.
Report
The Option Value of Municipal Liquidity: Evidence from Federal Lending Cutoffs during COVID-19
We estimate the option value of municipal liquidity by studying bond market activity and public sector hiring decisions when government budgets are severely distressed. Using a regression discontinuity (RD) design, we exploit lending eligibility population cutoffs introduced by the federal sector’s Municipal Liquidity Facility (MLF) to study the effects of an emergency liquidity option on yields, primary debt issuance, and public sector employment. We find that while the announcement of the liquidity option improved overall municipal bond market functioning, lower-rated issuers additionally ...
Working Paper
Decentralization and Overborrowing in a Fiscal Federation
We build an infinite horizon equilibrium model of fiscal federation, where anticipation of transfers from the central government creates incentives for local governments to overborrow. Absent commitment, the central government over-transfers, which distorts the central-local distribution of resources. Applying the model to fiscal decentralization, we find when decentralization widens local governments? fiscal gap, borrowings by both local and central governments rise. Quantitatively, fiscal decentralization accounts for from 19 percent to 40 percent of changes in general government debt in ...
Working Paper
Premium Municipal Bonds and Issuer Fiscal Distress
Economic theory suggests that bond issuers of lower credit quality or higher opacity should be more likely to issue bonds with premium coupons (higher coupon rates relative to yields at issuance). Using a comprehensive data set of municipal bonds issued between 1992 and 2012 by more than 21,000 issuers, we show that this has not been the case until the early 2000s. We examine what changed in this market to bring it into greater alignment with economic principles. We argue that the Government Accounting Standards Board?s Statement 34 that required the use of accrual accounting rules in ...