State General Obligation Research Articles

Status Quo Bias in Municipal Bond Underwriter Selection

Status quo bias is the tendency to select a previously chosen alternative disproportionately often in decision-making. Selecting the status quo when the current state is not objectively superior to other available alternatives results in a suboptimal outcome. This article extends the concept of status quo bias to municipal debt issuance. It analyzes a specific behavioral decision-making situation involving a state government that repeatedly uses the same underwriting firm disproportionately often, even when use of the same underwriter continually returns higher interest costs. the article uses data on California state general obligation bonds and Monte Carlo simulation techniques to analyze several paths of interest costs that deviate from a hypothetical optimal outcome. the analysis offers useful insights for state government debt management in complex and evolving markets where, in some cases, repeated use of the same underwriting firm might result in continually higher interest costs and limit interest cost savings.

State Government Use of the Same Underwriting Firm and the Impact on Borrowing Costs

Repeated use of the same underwriter can have a significant impact on issuance costs. On the one hand, an issuer may accumulate relevant information from using the same underwriter for multiple issues, which can reduce information costs and lower borrowing costs. On the other hand, repeated use of the same underwriter can raise borrowing costs if organizational learning is limited and the issuer and underwriter together continue with previous errors in issuance strategy, leading to greater risk-taking and more inefficiency. Despite its importance, existing research on repeated use of the same underwriter in municipal debt issuance is limited because prior work ignores non-linear effects on municipal borrowing costs. This article draws from theories on transaction costs, relationships, and organizational learning to test hypotheses about the non-linear impacts of repeated use of the same underwriter on municipal borrowing costs. the article analyzes data on California state general obligation bonds using a menu of estimation techniques. A key finding is that after a critical threshold, borrowing costs tend to decrease as the state government repeatedly uses the same underwriter in debt issuance. the study enriches existing knowledge on the interdependence between issuers and underwriters and presents useful insights for state debt management programs.

Underwriting of Municipal Debt and Placement Risk Premiums in Broker-Dealer Market Transaction Prices

This study examines the relationship between underwriter placement risk and market transaction prices using a sample of state general obligation bonds. We proxy underwriter placement risk using three variables: “when-issued” trades, underwriter syndicate size, and bond sale method. When-issued trades and larger underwriting syndicates have an inverse association with transaction prices (stated as percentage of par) and have a positive association with transaction yields (based on transaction price), all else constant. Negotiated sales have a positive relationship with transaction prices and a negative relationship with transaction yields.

The Market(s) Left Behind: Price Formation in Municipal Secondary Trades

This study addresses the determinants of municipal secondary trade prices for state general obligation bonds issued during 2005-2010. I find that a two-component finite mixture model, as postulated in the hypothesis of price dispersion under market opacity, remains the best specification for the municipal secondary market. There are distinct pricing regimes that persist even after controlling for the effects of illiquidity, market segmentation, fixed costs, and market fundamentals. Consistent with the theory of information economics, some municipal transactions (predominantly smaller household trades) are facing inferior prices in the municipal OTC market. Moreover, trades in the more informed price regime appear to be facing prices that became even more favorable during and after the Great Recession, while trades in the less informed price regime appear to be worse-off during the same period.

Credit and Credibility

Financial crises, municipal bankruptcies, and fear of contagious sovereign default have raised questions about the competency and character of politicians and public managers, but the credibility of private sector credit rating agencies and bond ratings may be the more relevant target of scrutiny. This article examines the credibility of government bond ratings in light of market institutions creating incentives to inflate ratings. Using yield spreads as interval indicators of bond ratings and historical ratings of state general obligation (GO) bonds from 1975 to 2002, a Granger-causality and vector autoregression analysis of the average ratings in the Moody’s and Standard and Poor’s portfolio of state GO bond ratings indicate that ratings are sensitive to market dynamics. Such market endogeneity confirms concerns about the credibility of government bond ratings and points to the necessity of considering institutional reform in the bond rating market.

An Analysis of the Effects of Online Fiscal Disclosure on Municipal Bond Issuances

The purpose of this study is to examine the effectiveness of states’ online fiscal disclosure processes for municipal bond issuances. This study conducts a comprehensive review of the factors that impact public borrowing costs in municipal bond issuances and tries to find other “costless signaling.” One way to improve the performance of public agencies is to improve online fiscal disclosure, which could lower the public borrowing cost. This study evaluates the effects of two forms of online fiscal disclosure: online budget reports and online Comprehensive Annual Fiscal Reports (CAFRs). The empirical estimates show that in a sample of state general obligation bonds, online budget reports have a statistically significant effect on the cost of municipal bond issuances, while online CAFRs do not have such an effect.

Public Pension Promises: How Big Are They and What Are They Worth?

ABSTRACTWe calculate the present value of state employee pension liabilities using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is $3.20 trillion. If pensions have higher priority than state debt, the value of liabilities is much larger. Using zero‐coupon Treasury yields, which are default‐free but contain other priced risks, promised liabilities are $4.43 trillion. Liabilities are even larger under broader concepts that account for salary growth and future service.

The influence of auditor term length and term limits on US state general obligation bond ratings

Improving transparency and enabling the principal to hold its agents accountable is a major issue in any principal agent relationship. This paper focuses on the role of public auditors in this task and presents evidence on the impact of auditor term length and term limits on government performance measured by state credit ratings at the US State level. I find no clear evidence for the influence of auditor term length, but strong evidence for a positive and significant influence of term limits on state credit ratings. Auditors who face a binding term limit are associated with higher credit ratings.

The Impact of Budget Stabilization Funds on State General Obligation Bond Ratings

This study examines the impact of budget stabilization funds (BSFs) on state general obligation (GO) bond credit ratings. While a number of past empirical papers have examined the effect of various fiscal institutions on state GO bond ratings; to date, BSFs have been largely ignored in the literature. Model estimates show that neither the choice to have a statutory BSF versus a constitutional BSF or the size of a BSF has any apparent impact on credit ratings. However, weak deposit rules are associated with lower credit ratings while weak withdrawal rules are associated with higher credit ratings.

Public Pension Promises: How Big are They and What are They Worth?

We calculate the present value of state employee pension liabilities as of June 2009 using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is $3.20 trillion. If pensions have higher priority than state debt, the present value of liabilities is much larger. Using zero-coupon Treasury yields, which are default-free but contain other priced risks, promised liabilities are $4.43 trillion. Liabilities are even larger under broader concepts that account for projected salary growth and future service.

Comparative costs of negotiated versus competitive bond sales: new evidence from state general obligation bonds

Previous work on the interest cost implications of the municipal bond underwriting method of sale decision has produced results asserting that competitive bid sales result in lower interest costs. However, negotiated offerings still dominate the municipal market. This paper invokes financial certification theory to explain the apparent paradox. After correcting for selection bias which is predicted by the theoretical model, empirical estimates show that for a sample of state general obligation bonds, negotiated offerings have at worst no higher and perhaps lower interest costs.

Rank order analysis of state general obligation bond ratings

This study extends research which suggests the possibility that different economic variables might have been emphasized by Moody’s in establishing state bond ratings. The objectives and the scope of the earlier study preclude formal testing, and the Scheffe test is not the proper statistical tool to investigate the issue. This study uses rank order analysis to conduct a formal test. It confirms the existence of regionalization in state bond ratings. It finds statistical evidence that beginning in the early 1970s different economic variables were emphasized in establishing the ratings. The change in economic variables coincides with the administrative change in Moody’s in 1972.

Fiscal determinants of state borrowing costs

This paper examines the fiscal determinants of net interest cost on new State general obligation bond issues. Our empirical results indicate that actual fiscal performance does have information content for States' borrowing costs beyond the information already impounded in bond ratings.

State General Obligation Bond Credit Ratings

State General Obligation Bond Credit Ratings