Municipal Bond Research Articles

Climate, race, and the cost of capital in the municipal bond market.

Both climate risk and race are factors that may affect municipal bond yields, yet each has received relatively limited empirical research attention. We analyzed > 712,000 municipal bonds representing nearly 2 trillion USD in par outstanding, focusing on credit spread or the difference between a debt issuer's interest cost to borrow and a benchmark "risk-free" municipal rate. The relationship between credit spread and physical climate risk is significant and slightly positive, yet the coefficient indicates no meaningful spread penalty for increased physical climate risk. We also find that racial composition (the percent of a community that is Black) explains a statistically significant and meaningful portion of municipal credit spreads, even after controlling for a variety of variables in domains such as geographic location of issuer, bond structure (e.g., bond maturity), credit rating, and non-race economic variables (e.g., per capita income). Assuming 4 trillion USD in annual outstanding par across the entire municipal market, and weighting each issuer by its percent Black, an estimated 19 basis point (bp) penalty for Black Americans sums to approximately 900 million USD annually in aggregate. Our combined findings indicate a systemic mispricing of risk in the municipal bond market, where race impacts the cost of capital, and climate does not.

ANTI‐PUBLIC FINANCE? The Democratic Effects of Municipal Bond Markets

AbstractMunicipal bonds are a financial instrument once largely limited to North America. Today, they are appearing in international development reports as a novel best‐practice for closing the world's infrastructure funding gap and for promoting democracy. Critics of financialization have argued that municipal bonds have had the opposite effect: they have deepened austerity, ceded control of democratic municipalities to the global financial industry, and depoliticized public decision‐making. Yet in this article, I observe a relationship between democracy, politics and finance which contrasts with the now common uses of ‘financialization’ popularized by critical scholars in Euro‐American universities. I argue that, elsewhere in the world, capital markets have come to be understood as an important element of democratization. To make this argument, I develop the concept of ‘financial publics’—a group of strangers participating in a reflexive and reciprocal style of address through which they negotiate their financial relationships with one another. Using this concept, I analyze data drawn from over two years of ethnographic research on one of the most noteworthy experiments in municipal finance in the global South: the City of Dakar's failed attempt to issue the first ever municipal bond on the Regional Stock Exchange of West Africa.

The Price of Safety: The Evolution of Municipal Bond Insurance Value

Economic theory predicts that bond insurance lowers issuers’ financing costs by resolving asymmetric information and mitigating credit risk. With comprehensive data over the last 36 years, we find increasingly diminished empirical support for these models. The value of insurance in resolving asymmetric information beyond that resolved by credit ratings and other observable bond characteristics is economically minimal. The average gross value of insurance ranges from 4 to 14 bps when bond insurers offer Aaa-rated coverage. However, this gross value becomes insignificant after 2008 when Aaa-rated insurance no longer exists. Evidence suggests that the lack of insurance benefit in the postcrisis period is attributable to the deteriorated creditworthiness of insurance companies. Examining noninterest saving explanations for the continued use of insurance in the no-Aaa insurance market, we find evidence that issuers purchase insurance out of habit (with insurance value most diminished for habitual purchasers with low governance quality) and for the convenience it affords in default, but no evidence that insurance improves secondary market liquidity. This paper was accepted by Gustavo Manso, finance. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4813 .

Municipal bankruptcies and crime

While the importance of municipal bonds for the provision of public services is well-documented, the consequences of municipal bankruptcies remain understudied. We contribute to this literature by studying the effects of municipal bankruptcies on crime. Using the staggered difference-in-differences approach and agency-level crime data, we find that violent and property crime rates rise after successful (approved by the bankruptcy courts) Chapter 9 bankruptcy filings. The association between successful municipal bankruptcy and crime remains robust to alternative estimation methods, including a novel empirical technique that allows for the treatment effect heterogeneity and dynamics, and several robustness checks and falsification exercises. Our exploratory evidence suggests that the rise in crime rates is due to lower public safety expenditures. Our findings highlight the importance of efficient financial management for local government entities and the need for particular attention to law and order in the local jurisdiction going through bankruptcy.

Tropical blue carbon: solutions and perspectives for valuations of carbon sequestration

Tropical marine ecosystems provide a wide range of provisioning, regulating, supporting and cultural services to millions of people. They also largely contribute to blue carbon sequestration. Mangroves, seaweeds, and seagrass habitats are important because they store large amounts of organic carbon while fish play a fundamental role in the carbon transport to deep waters. Protecting and restoring tropical marine ecosystems is of great value to society because their decline impairs the vital services they provide, such as coastal protection and seafood supplies. In this marine policy paper, we present options for enhancing blue carbon sequestration in tropical coastal areas. In addition, we outline the economic value of four components of coastal ecosystems (mangroves, seagrass beds, seaweed forests and fish) and discuss the economic levers society can apply to ensure the end of the current gross mismanagement of tropical blue carbon ecosystems. Market-based solutions, such as carbon taxes or fines for violations that use the ‘polluter pays' principle, can be very effective in achieving national or international climate agreements. Private investment can also finance the preservation of blue carbon ecosystems. One widely known financing method for blue carbon conservation, particularly of mangroves, is the use of municipal bonds, which can be issued like traditional bonds to finance the day-to-day obligations of cities, states and counties. Non-philanthropic investments can also be used in order to protect these ecosystems, such as debt-for-nature swaps and the improved application of regulatory frameworks. Overall, the protection of tropical marine ecosystems is an ecological imperative and should also be seen as an opportunity for new revenue streams and debt reduction for countries worldwide.

The role of adverse outcomes in municipal debt costs

This study investigates whether municipal bond prices reflect adverse outcomes (i.e., material noncompliance with laws and regulations and questioned costs) and the interactive effect of adverse outcomes and internal control weaknesses. Using hand-collected data from 866 official registration statements, our results suggest that adverse outcomes are an important determinant of initial bond yields and help explain the underlying relationship between weaknesses in internal control and initial bond yields. Specifically, the municipal bond market penalizes governments with adverse outcomes, with a greater penalty if an adverse outcome is accompanied by a material weakness in internal control.

The Research Developments and Trend of Municipal Bonds: A Bibliometric Analysis

This study aims to explore and analyze the development and trend of the topic of municipal bonds in the fields of economics and business. Research data using peer-reviewed journals, as many as 478 journals sourced from the Scopus database. Data analysis used a bibliometric approach. Bibliometric analysis utilizing the help of R-biblioshiny and VOSviewer. The research results show an interesting trend of this research from various indicators based on the frequencies and citations of the publications. More importantly, some popular research areas and topics have been uncovered to analyze municipal bonds, which serve as useful inferences for future studies in Indonesia. There are many studies on municipal bonds, but there are still few studies that map the topic of municipal bonds with a bibliometric approach with the help of R-Biblioshiny and VOSviewer to get meaningful and valuable results. That is the novelty of this research.

The Potential of Municipal Sukuk Issuance in Indonesia - A Review of Theoretical Research

The main objective of this study is to provide local authorities with municipal Sukuk as an alternative to financing local infrastructure and developing areas. This study reviews the previous literature examining contemporary municipal sukuk and Discussed issues related to restrictions on the issuance of municipal sukuk. The research shows that the barriers to municipal Sukuk issuance are: Regional Barriers, Credit risk, Political Risk, Credit Weakness among stakeholders, Lack of through understanding of Shariah and financing and implementation. It was an exploratory study and aimed to identify barriers to becoming municipal bonds. Blocks of municipal Sukuk are listed from all possible sources. The study proposes some practical ways to overcome the obstacles to the provision of municipal sukuk in order to promote more municipal sukuk in various regions of the country to support sustainable development through equitable infrastructure distribution.

Unconventional monetary policy and local fiscal policy

Following the onset of the pandemic, the Federal Reserve employed an unconventional monetary policy that directly intervened in municipal bond markets. We characterize the fiscal and macroeconomic implications of such central bank actions in a New Keynesian model of a monetary union. We assume that state and local governments are subject to a loan-in-advance constraint, reflecting that with lumpy cash flows, they often finance a fraction of expenditures by issuing short-term bonds. The municipal debt is held by financial intermediaries, who also supply credit to the private sector. Direct central bank purchases can transmit to the economy through two main channels: (1) by alleviating cash flow problems of the regional governments and (2) by accelerating lending to the private sector if credit constraints ease more broadly. By quantifying the relative importance of these channels, we highlight that the central bank’s actions lead to sizable increases in private investment but have more muted effects on state and local government expenditures. In addition, we also show the transmission of direct federal government aid through intergovernmental transfers is markedly different from unconventional policy.

Impact of Corporate Subsidies on Borrowing Costs of Local Governments: Evidence from Municipal Bonds

Abstract We analyze the impact of $40 billion of corporate subsidies given by US local governments on their borrowing costs. We find that winning counties experience a 15.2 basis points (bps) increase in bond yield spread as compared to the losing counties. The increase in yields is higher (18–26 bps) when the subsidy deal is associated with a lower jobs multiplier or when the winning county has a lower debt capacity. However, a high jobs multiplier does not seem to alleviate the debt capacity constraints of local governments. Our results highlight the potential costs of corporate subsidies for local governments.

Analysis of urban slum infrastructure projects financing in Ghana: A closer look at traditional and innovative financing mechanisms

Rapid urbanisation in developing countries has engendered unregulated slum development to provide residences for economic migrants who travel to cities to pursue hopes of a secure future. The development of new financial approaches could play a critical role in unravelling the issues associated with slum development, particularly in emerging economies such as Ghana. Hence, this study investigates slum emergence in Ghana and assesses traditional and innovative financing mechanisms to drive the country’s re-development. Specifically, the study assessed critical indicators of city-urban slums, established critical city-urban slums infrastructure requirements, and examined the traditional and innovative tools of financing city-urban slums to develop more socially equitable and inclusive infrastructure. This research adopted a quantitative research strategy couched within a positivist paradigm and deductive reasoning. Surveys were used to solicit responses from selected stakeholders using purposive sampling. Data was analysed using mean score ranking, one sample t-test and relative importance index (RII). Emergent findings revealed that ‘housing quality’ was the most critical measure of city-urban slum conditions, followed by ‘access to improved sanitation’. Additionally, the findings also asserted ‘virtuous sanitation’ was the most important infrastructure requirement, followed by ‘appropriate disposal of waste facilities’. Cumulatively, the findings suggest that the most prevalent and effective traditional financing tool was to incorporate a slums infrastructure development fund and use taxes and empower urban local bodies (ULB) with increased municipal budgets. Finally, in relation to innovative forms for financing, public–private partnership (PPP) was found to be most effective, followed by municipal bond. In conclusion, the study recommends the participation of industry professionals and governing agencies in the pursuance of these financing options to drive the re-development of slums to meet the UN’s sustainable development goals (SDGs) of ensuring sustainable cities by 2030.

Sea-Level Rise Exposure and Municipal Bond Yields

Abstract Municipal bond markets began pricing sea-level rise (SLR) exposure risk in 2013, coinciding with upward revisions to worst-case SLR projections and accompanying uncertainty around these projections. The effect is larger for long-maturity bonds and not solely driven by near-term flood risk. We use a structural model of credit risk to quantify the implied economic impact and distinguish between the effects of underlying asset values and of uncertainty. The SLR exposure premium exhibits a trend different from house prices and is unaffected by house price controls. Together, our results highlight the importance of climate uncertainty in driving municipal bond prices. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online

Market-based Financing Through Municipal Bond in India: Investor’s Checklist Using Structural Equation Modeling (SEM)

This paper aims to analyze the investor’s perspective toward municipal bonds and to inspect the success potential of municipal bonds in India from 2010 to 2020. The research’s conceptual model is drawn using PLS-SEM for the factors impacting investor decisions toward investment in bonds issued by urban local bodies in India. Results show that “credit rating,” “yields,” “tax benefit,” and “financial soundness” significantly affect the choice of investment in municipal bonds by retail investors. However, “transparency,” “liquidity,” and “investor awareness” are not found to be significant. Bond issuers can use the model to recognize the factors impacting investors’ prioritization for investments in municipal bonds, which can also help them target a bigger investor base. The study relies on subjective data provided by retail investors and may not be the clear-cut performance indicators. The limitation of the time frame for the study over 10 years will restrict the results specifically for that period. The importance of retail investors in developing countries’ municipal bond markets has been overlooked. The study’s key contribution will be to assist and empower new retail investors to have confidence in participating in this fixed-income financial instrument.

The great wall of debt: Real estate, political risk, and Chinese local government financing cost

Chengtou bond is the only asset with market prices that can capture the funding cost of Chinese local government debt. In contrast to the U.S. municipal bonds, Chengtou bonds are issued by private corporations but implicitly guaranteed by local and the central governments, which are reflected by novel risk characteristics—real estate GDP and political risk. One standard deviation increase in local real estate GDP (political risk) corresponds to 10 (9) basis points decrease (increase) in bond yields, respectively. However, conditional on political risk, real estate GDP actually increases bond yields, suggesting that only local governments with low political risk can enjoy the low funding costs driven by high real estate growth.

Municipal bond volatility spillover modeling with COVID-19 effects by hybrid integration of GARCH and machine learning: The connectedness of U.S. states and South African bond markets

After the passage of the United States Africa Growth and Opportunity Act (AGOA), the emerging market economy of South Africa (SA) recorded substantial increases in duty-free exports to the U.S. Any loss or disruption of AGOA privileges could undermine SA as a trade partner with designated states in the U.S. For U.S. states most affected by the passage of the 2017-2018 Tax Cuts and Jobs Act (e.g., SALT states) along with the COVID-19 pandemic effects, the elimination of the tax exemption impacted how state governments assist in funding international trade. This paper presents a novel hybrid EGARCH conditional volatility and artificial neural network model to map the COVID-19 effect on volatility spillovers between the SA government bond market and state-issued U.S. municipal bonds traded in secondary markets. Our empirical investigation provides three innovations. First, this study addresses illiquidity and informed trading impairments by observing over 11.5 million municipal bond trades. Second, we provide new evidence that a radial basis function artificial neural network enhanced by conditional volatility and fundamental factors can effectively map the geographical bond market spillover transmission between SA and individual U.S. states. Third, on state-based muni trades, we report how the AR (1) process is weighted positively across all East coast states during the global pandemic. Lastly, the study details how COVID-19 and South African conditional volatility impacted the returns of recorded trades of municipal bonds in SALT states. A global summary of the findings concludes with a discussion of how precious metals trading contributes to the performance of state-based municipal bonds.

The impact of term limits on municipal borrowing costs

Gubernatorial term limits constrain the number of terms that a governor can serve in office. In this regard, previous models (with imperfect information) indicate that governors tend to responsibly spend during the first term to build political capital, while the last term is associated with higher spending. In estimation with state fixed effects, we find that municipal bonds issued during a governor's last term are associated with higher yields. Such yields are related to spending in construction, highways, and pensions, with the effect mitigated when the governor runs for future political office. We also document that house term limits that constrain the terms of legislators are associated with higher bond yields.

Government's implicit guarantee and the credit spread of the quasi-municipal bonds

Breaking the rigid repayment of municipal investment bonds (MIBs) is essentially releasing the implicit guarantee of local governments. We analyze the effects of implicit government guarantees on MIBs’ credit spreads and find that regional economic strength, local government's financial strength, and fiscal balance have significant effects on the credit spreads of MIBs; the effects of implicit government guarantee on the credit spreads of MIBs depend on the regional economic development status; the effects of implicit government guarantee on the credit spreads are significant across different MIBs issued by public welfare institutions, quasi-public welfare institutions, and comprehensive municipal investment companies.

Do Municipal Bond Dealers Give Their Customers “Fair and Reasonable” Pricing?

ABSTRACTMunicipal bonds exhibit considerable retail pricing variation, even for same‐size trades of the same bond on the same day, and even from the same dealer. Markups vary widely across dealers. Trading strongly clusters on eighth price increments, and clustered trades exhibit higher markups. Yields are often lowered to just above salient numbers. Machine learning estimates exploiting the richness of the data show that dealers that use strategic pricing have systematically higher markups. Recent Municipal Securities Rulemaking Board rules have had only a limited impact on markups. While a subset of dealers focus on best execution, many dealers appear focused on opportunistic pricing.

Things Fall Apart: Fixed Income Markets in the COVID-19 Crisis

This article provides a critical appraisal of the March 2020 crisis in fixed income markets. We synthesize the main events, characterize what appears to be an emerging consensus on what caused the market breakdowns, summarize how the Federal Reserve's actions contributed to its resolution, and discuss potential lasting effects of the crisis. This review makes clearer the fragilities and interconnectedness that characterize the current fixed income market structure and their effects on liquidity provision. We argue that the current market structure, combined with the continued growth of Treasury markets, corporate and municipal bond markets, and particularly, mutual funds, raises the specter that periodic instability may remain a feature of fixed income markets.

Air pollution and local government financing costs: Evidence from the Chinese municipal corporate bond spread

Using a sample of Chinese municipal corporate bonds from 2011 to 2019, this paper investigates the effect of city-level air pollution on local government financing costs. We find that cities with severe air pollution tend to have higher municipal corporate bond spreads, indicating that air pollution leads to higher local government financing costs. Moreover, air pollution is associated with lower economic growth, decreased population, and worse fiscal conditions, supporting the “implicit guarantee channel” that air pollution curtails implicit guarantees for municipal corporate bonds and thus increases bond spreads. Furthermore, the detrimental effect of air pollution is more salient for municipal corporate bonds without explicit guarantees, implicitly guaranteed by governments at lower administrative levels, and issued by local government financing vehicles located in regions with less marketization. Our study enhances understanding on the effect of air pollution on agents’ behaviors and provides guidance for reducing local government financing costs.