We empirically test the reputation and disciplining hypotheses on the potential impact of Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) on Standard & Poor’s (S&P) state government credit ratings and bond yields. Our empirical findings indicate that S&P ratings after Dodd-Frank are higher and more stable, as evidenced by fewer total rating changes. We find fewer overall negative rating actions, fewer rating downgrades, and more rating upgrades. We also find that after Dodd-Frank bond yields are lower and that Dodd-Frank impacted bond yields through credit ratings. The impact of Dodd-Frank on bond yield is significant across all rating classes. Our findings are consistent with the disciplining hypothesis, and we find no support for the reputation hypothesis.
What went wrong? Why did seemingly rational bond investors continue to purchase Puerto Rican debt with only a modest risk premium, even though the macroeconomic fundamentals were dismal? Given gloomy macro economic fundamentals and relatively low risk premia, investors were either stunningly myopic or Puerto Rican debt was implicitly insured by the U.S. Treasury. The rational investor model rules out the former hypothesis.
This project examines the latter hypothesis, which we label the “Treasury Put.” The expectation of a federal bailout was perfectly reasonable given past behavior by the Federal Government, especially the prior bailout of the city of New York. Evaluating the Treasury Put hypothesis with a minimal set of assumptions is possible given two fortuitous features – a unique characteristic of Puerto Rican bonds and a “seismic shock.” Puerto Rico issued both uninsured and insured general obligation bonds. These bonds were issued on the same day and, in many cases, with the exact same maturity. These features allow us to compute accurately the risk premia on Puerto Rican bonds. The second feature was the non-bailout of the city of Detroit in 2013 that effectively extinguished the Treasury Put. Puerto Rican risk premia were stable before the Detroit bankruptcy and bracketed by the risk premia on Corporate Aaa and Baa bonds. However, after the Detroit bankruptcy, risk premia rose dramatically, thus documenting the existence of a sizeable Treasury Put and a significant misallocation of capital to Puerto Rico.
Source: Yimeng Yin -The Nelson A. Rockefeller Institute of Government, Don Boyd – Center for Policy Research, The Rockefeller College, University at Albany, July 11, 2018, Paper prepared for: Brookings Municipal Finance Conference July 17, 2018
…. Research suggests that the real world differs from these assumptions, in some ways that mean the assumptions may understate risks, and in other ways that mean the assumptions may overstate risks. Investment returns may not be normally distributed and may not be independent over time. Perhaps more important, investment returns and tax revenue may be correlated: a poor economy may cause investment returns to fall short of expectations, and may also cause tax revenue to fall short. The resulting increase in required employer contributions may cause additional fiscal pressure if increases come when tax revenue is low.
We address these issues, focusing on the correlation between tax revenue and the economy, by building a small macroeconomic model that can generate internally consistent stochastic scenarios of growth in real gross domestic product (GDP) and returns from stock and bond investments. ….
Note: This paper will be presented at the 2018 Municipal Finance Conference on July 16 & 17, 2018.
State governments with large unfunded pension liabilities are paying more to borrow from capital markets than are other states, according to Chuck Boyer of the University of Chicago Booth School of Business.
In the paper, “Public pensions, political economy and state government borrowing costs,” to be presented at the 2018 Municipal Finance Conference at Brookings this week, Boyer argues that markets view states with large pension deficits as riskier investments. His evidence suggests that states are already paying for municipal government’s unfunded pension liabilities in the form of higher borrowing costs. He asks two questions: 1) how are state governments’ borrowing costs affected by unfunded pension obligations? and 2) do states with political constraints face higher borrowing costs?
Boyer constructs a panel dataset using each state’s Comprehensive Annual Financial Reports for the period 2005 to 2016. He focuses on balance sheet variables—revenues, expenses, assets, and liabilities—to capture a state’s financial health and credit default swap (CDS) spreads – the premium paid to protect buyers from an issuer defaulting – to measure borrowing cost. The author reasons that CDS reflects market sentiments better than market yields because CDS are more liquid, and because they are standardized, whereas market yields may be affected by additional features of a particular bond.
Public pensions, political economy and state government borrowing costs
Source: Chuck Boyer, University of Chicago Booth School of Business, current draft: July 11, 2018
I find that public pension funding status has a robust and statistically significant relationship with state borrowing costs, as measured by credit default swap spreads. A one standard deviation increase in the net pension liability to GDP ratio is related to an 18 basis point increase in CDS spreads. This effect is most pronounced among states with constitutional protection for pension liabilities, suggesting the markets perceive these legal protections as material. I also find suggestive evidence that states with more powerful unions pay higher borrowing costs. Results are robust to using spreads from the underlying bonds themselves. These findings highlight the fact that states are already paying for potential future pension problems through higher borrowing costs.
Related: presentation slides
When Needed Public Pension Reforms Fail or Appear to Be Legally Impossible, What Then? Are Unbalanced Budgets, Deficits and Government Collapse the Only Answer?
Source: James E. Spiotto, Chapman Strategic Advisors, May 30, 2018
The problem of underfunded public pensions confronts a number of states and local governments in the United States. In the past, numerous public employers in the United States have agreed to pension benefits that now appear challenging to afford given current revenues and the increased cost of providing governmental services. Further, this challenge has been exacerbated by past failures to set aside sufficient moneys to meet the pension benefits obligations incurred to date. All of this is occurring on the heels of the Great Recession of 2007, followed by an anemic recovery, and at a time many states and local governments are faced with an aging infrastructure that must be attended to and increased demands for basic public services (sanitation, water, streets, schools, food inspection, fire department, police, ambulance, health and transportation) that must be met. Because the public pension underfunding problem pits the requirement of meeting pension obligations against the need to provide for essential public services, all citizens have an interest in the fair and equitable solution to the dilemma.
Unfortunately, a just and effective method of resolving unaffordable public pension obligations has been elusive for some public governmental employers and employees. This is due in part to promised pension benefits costs exceeding the government’s ability to pay and the failure to fund promptly the incurred obligations. In some cases, solving the problem has been complicated by the lack of any ability to adjust or modify pension benefits to those that are sustainable and affordable to the fullest extent possible without adversely affecting the funding of essential public services. This paper will provide a review of some legal and practical obstacles that have been making needed pension reform and balancing the budget difficult, if not impossible, and will suggest possible new approaches to the problem that have not yet been tried. …..
Related: presentation slides
Source: S&P Global Finance, July 16, 2018
The credit quality of most rated U.S. public colleges and universities was relatively stable in fiscal 2017, except for lower-rated schools, whose credit issues continued. Enrollment and demand metrics were favorable across higher-rated categories and as a sector, although schools in the ‘BBB’ and speculative-grade categories generally saw theirs weaken.
U.S. Not-For-Profit Private Universities’ Fiscal 2017 Median Ratios: Competition And Affordability Continue To Be Main Credit Risks
Source: S&P Global Finance, July 16, 2018
Despite the sector facing continuous challenges in the areas of competition and affordability, S&P Global Ratings’ key median indicators for U.S. not-for-profit private universities in fiscal 2017 were relatively flat as compared with those from a year earlier, reflecting the sector’s continued ability to withstand medium-term pressures.
– Statewide free college, also known as “Promise” programs, have expanded rapidly in states across the country, and older free college programs can provide lessons for the design of these programs.
– Advocates of the model point to their structure as a free benefit and to the goal of universality as potential drivers of long-term political sustainability: that increased participation and a clear message will help increase and retain aid funding.
– This report identifies and studies six statewide Promise programs that were in operation through the Great Recession to see how they fared. Their resiliency during that significant downturn demonstrates that the model might in fact benefit from more enduring funding support, and that budgetary protections, social insurance-like design, and the defined benefit structure meant that means-tested free college programs also enjoyed that sustained funding.
Can a college get better and smaller at the same time? ….The more common case involves sustained incremental cutting and watering-down. That takes the form of replacing full-time faculty with adjuncts, replacing administrators with contracted services, raising class caps, outsourcing campus functions, and the like. As short-term measures, many of those make sense at first, and a few may make sense generally. But after the low-hanging fruit has been picked, the trends don’t stop. This approach assumes, whether consciously or not, that the hard times are temporary. That might make sense in the aftermath of a natural disaster, but it’s delusional in the face of long-term demographic decline. Over time, the decline tends to outpace the incremental cuts, and the college has to resort to layoffs. Those are a nightmare for all involved. Aside from the frustration and hand-wringing of the usual approach, there’s a lack of vision. The challenge for each budget year is to keep doing essentially the same thing, but with less. But with long-term demographic decline, doing essentially the same thing guarantees continuing to get disappointing results. As a long-term survival strategy, it’s exactly wrong. ….
Source: Emily Raimes, Nicholas Samuels, Kenneth Kurtz, Ted Hampton, Baye Larsen, Marcia Van Wagner, Genevieve Nolan, Matthew Butler, Pisei Chea, Timothy Blake, Moody’s, Sector Comment, State government – US, July 2, 2018
This report is part of a series that identifies changes in state general obligation (GO) and issuer ratings and outlooks. We produce the report on a quarterly basis; the last publication was April 2018. We maintain GO or equivalent issuer ratings for 49 states. Stable outlooks apply to 45 states, and four states have negative outlooks. The data included in this report reflect rating changes for each state by year, a list of all state GO or issuer ratings by category, and a list of all state outlooks.
From the abstract:
Wide variation in institutional structure and funding patterns in public libraries make this government function useful for exploring the effect of these differences on expenditures. Based on literature related to willingness to pay, special districts, and fiscal illusion, we hypothesize that libraries with taxing authority and more revenues from nonlocal sources will have higher levels of spending. We use data from an Annual Public Library Survey, and U.S. Census data, in ordinary least squares (OLS) regressions for 2007 and 2010. We find that taxing authority leads to increased spending, as expected. However, the results of funding sources are contrary to expectations; relative reliance on nonlocal sources is generally associated with lower levels of spending. This may be due to “crowding-out” of local sources, and there may also be some effect from reduced state aid following the Great Recession.
Source: Child Trends, June 2018
Two new reports from Child Trends provide a comprehensive overview of how states use various funding sources to support child welfare agencies. The first report highlights state variation in per-child spending by child welfare agencies, finding that agencies spent $12.8 billion (approximately $172 per child) in federal funds and $16.3 billion (approximately $222 per child) in state funds in fiscal year 2014.
Federal and State/Local Child Welfare Agency Spending per Child, 2004–2014
Source: Dana Connelly, Kristina Rosinsky, Child Trends, Research Brief, Publication #2018-12, June 2018
The second report highlights variation in how child welfare agencies use federal funding streams to finance their programs. This information can help policymakers, advocates, and other child welfare stakeholders review state approaches to child welfare financing and better understand how changes to funding streams will impact child welfare programs.
State Variation in Child Welfare Agency Use of Federal Funding Sources
Source: Dana Connelly, Kristina Rosinsky, Child Trends, Research Brief, Publication #2018-13, June 2018
5 things to know about children and SNAP
Source: David Murphey, Child Trends, June 28, 2018
A new Child Trends 5 explains how the Supplemental Nutrition Assistance Program (SNAP) impacts children’s well-being. SNAP serves a monthly average of more than 1 in 4 U.S. children. The single largest share of households with children receiving SNAP benefits are headed by a white, non-Hispanic adult.