The “Privatization” of Municipal Debt

Source: Ivan T. Ivanov – Federal Reserve Board, Tom Zimmermann – University of Cologne, July 12, 2018, Paper prepared for: Brookings Municipal Finance Conference July 17, 2018

State and local governments in the U.S. have substantially increased their reliance on private bank loans in the aftermath of the Great Recession. Using loan-level data on bank lending to U.S. municipal governments, we document that these loans have high effective debt priority and are likely to allow borrowers additional debt capacity. Specifically, banks loans to municipalities are highly collateralized, include additional seniority and guarantee provisions, and have short maturities. Consistent with the idea that financially weak borrowers are more likely to resort to higher priority debt, banks’ assessments indicate a non-trivial fraction of municipal borrowers to be high risk. Last, we show that exogenous adverse income shocks lead to a significant increase in bank financing in the debt structure of municipalities. These results suggests that the reliance of municipalities on private debt is likely to increase in an environment of eroding fiscal positions.

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Colin MacNaught (BondLink)