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Municipal Finance Conference Papers

New research presented at the 5th Annual Municipal Finance Conference

The 5th annual Municipal Finance Conference—held in Washington on July 12, 2016—was made possible through partnership between the Rosenberg Institute of Global Finance at Brandeis International Business School, Olin Business School at Washington University in St. Louis, and the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy.

At the conference, academics, practitioners, issuers, and regulators gathered to discuss 10 new papers on municipal markets and municipal finance.

See below to read brief summaries of all 10 papers or to download the full version of each paper.

Neighboring cities become vulnerable when nearby areas encounter financial problems

Richard A. Ciccarone, President & Chief Executive Officer of Merritt Research Services, LLC

When cities and counties encounter financial distress, nearby governments face an increased risk of suffering the spillover effects of the crisis. This “contagion risk” is often caused by municipalities’ common vulnerabilities or interdependencies, but analysts often disagree about what specific characteristics put nearby municipalities at the greatest risk. A new analysis from Richard A. Ciccarone of Merritt Research Services, LLC determines that the main drivers of contagion risk are negative population trends, high overlapping debt loads combined with high, unfunded pension , a limited capacity to raise taxes, and deferred infrastructure improvements that lead to more expensive financial obligations down the road. Using a model based on these factors to study cluster risk in almost 2,000 US cities, Ciccarone’s analysis determines that the most vulnerable cities are New Orleans, Detroit, Philadelphia, Pittsburgh, Chicago, Syracuse, Cincinnati, St. Louis, and Birmingham.

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Strict land use regulations are holding back income diversity in neighborhoods, reversing 100 years of progress

Peter Ganong, Harvard University
Daniel Shoag, Harvard Kennedy School

For over a century, from 1880-1980, incomes in poorer areas of the United States rose faster than incomes in richer areas—a phenomenon known by economists as income “convergence.” During that time, the convergence rate across states was about 1.8 percent a year, but that rate has weakened over the past three decades. The rate was less than half the historical norm from 1990-2010, and in the period leading up to the Great Recession there was virtually no convergence at all. A new paper from Peter Ganong and Daniel Shoag suggests the decline can be partly attributed to reduced labor mobility resulting from higher housing prices in wealthy areas. When those prices increase, they deter the migration of unskilled workers to those areas. But when land use for local housing supply is less regulated, workers of all skill types will choose to move to more productive locations. This migration pushes down wages in productive areas , generating income convergence. The findings have important implications not only for the literature on land use and regional convergence, but also for the literature on inequality and segregation.

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Wealthiest 0.5 percent have doubled their municipal debt share investments over past 25 years

Daniel Bergstresser, Brandeis International Business School
Randolph Cohen, Massachusetts Institute of Technology

Municipal debt is often owned directly by households. and direct investment by households remainsan important part of municipalities’ ownership structure. But a new paper from Daniel Bergstresser at Brandeis International Business School and Randolph Cohen at the Massachusetts Institute of Technology finds that more and more households are investing in tax-deferred accounts such as 401(k)s, 403(b)s, and IRAs, as opposed to municipal bonds. Because municipal bonds’ tax-exemption reduces their pre-tax yields, they are an unusual—and even inappropriate—asset for tax-deferred accounts. The result is that, since 1989, ownership of municipal debt has become increasingly concentrated among the wealthiest households. From 1989-2013, the share of households holding any municipal debt fell by almost half—from a 4.6 to 2.4 percent. The share of total debt that is held by the wealthiest 0.5 percent of households rose from 24 percent to 42 percent during that same time period. The demographic change is important because ownership of debt by voters affects the political will of borrowers to repay.

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Term limits backfire at state level, leading to increased government spending and fiscal volatility

Alex Abakah, Rutgers University
Semi Kedia, Rutgers University

Gubernatorial and legislative terms limits are thought to reduce wasteful government spending and curb political agency costs. But a new paper from Alex Abakah and Semi Kedia at Rutgers University suggests that term limits actually increase government spending and create significantly higher yields on municipal debt by generating fiscal volatility. Final gubernatorial terms, for example, are often associated with higher spending linked to the creation of politically riskier projects. In an analysis of government spending and earnings on municipal bonds issued by states with and without term limits, the authors find higher yields for all bonds issued from states with gubernatorial term limits. States with term limits for state legislators were associated with higher government spending. The results hold after controlling for bond level characteristics, macro-economic variables, time-varying state characteristics, along with time and state fixed effects. They also point to the importance of political institutions in municipal financing costs.

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Municipal bond yields are higher in states that are allowed to final for Chapter 9 bankruptcy

Pengjie Gao, University of Notre Dame
Chang Lee, University of Illinois at Chicago
Dermot Murphy, University of Illinois at Chicago

Policies on financially distressed municipalities differ significantly across US states, with some states allowing municipalities to file for Chapter 9 bankruptcy (“Chapter 9 states”), while others have strong policies in place to deal with distressed municipalities via state assistance programs (“Proactive states”). A new paper from Pengjie Gao at the University of Notre Dame and Chang Lee and Dermot Murphy at the University of Illinois at Chicago finds that such policy differences significantly affect local municipal borrowing costs. Local municipal bond yields in Chapter 9 states are higher and more cyclical than those in Proactive states. Moreover, following a default event in Chapter 9 states, the average yield of defaulted bonds increases more than those in Proactive states. Default events have a contagion effect among no-default bonds in Chapter 9 states, but not in Proactive states. Lower borrowing costs for local governments come at the expense of higher borrowing costs for the state government through a channel of counter-cyclical intergovernmental transfer. Proactive states bear more local credit risk than Chapter 9 states and as a result, their yields on state-issued general obligation bonds are higher.

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Benefits of the Advance Refunding Option (ARO) and why it’s a true “free lunch”

Andrew Kalotay, Kalotay Associates
Lori Raineri, Government Financial Strategies, Inc.

A new paper from Andrew Kalotay, Kalotay Associates, and Lorie Raineri, Government Financial Strategies, Inc., discusses the benefits of using the Advanced Refunding Option (ARO) to obtain bonds used to pay off another outstanding bond. Under an ARO, the new bond is often issued at a lower rate than the outstanding bond. The authors’ analysis shows that incorporating the ARO of the replacement issue provides a slower signal to advance refund than when it is ignored. In practical terms, disregarding the ARO of the replacement issue may lead to a sub-optimal advance refunding decision. Close to the call date, locking in savings with a hedge is preferable to sacrificing the advance refunding eligibility of the refunding issue.

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Thinking beyond Chapter 9 for distressed municipalities

Juliet M. Moringiello, Widener University Commonwealth Law School

In the wake of municipal bankruptcy filings in Detroit, Stockton, San Bernardino, and a handful of other municipalities, market participants, public officials and academics continue to question whether filing for Chapter 9 bankruptcy is the best solution to municipal financial distress. A new paper from Julie M. Moringiello proposes a different way of thinking about creditor priorities that extends beyond Chapter 9. Moringiello argues that it’s necessary to ascertain market expectations and consider the extent to which bankruptcy should honor those expectations. In order for Chapter 9 to be a more effective process for eliminating debt overhang, a more focused analysis of appropriate priorities is necessary.

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Using a better metric for calculating the lifetime cost of capital for municipal borrowers

Peter Orr, Intuitive Analytics
Martin J. Luby, DePaul University

Cost of capital metrics for state/municipal government and not-for-profit borrowers have evolved over time from net interest cost (NIC) to true interest cost (TIC) to all-in TIC. A new paper from Peter Orr of Intuitive Analytics and Martin J. Luby at DePaul University argues that each of these metrics is incomplete in that, by relying on debt service to maturity, they all ignore the likelihood of refinancing. This represents a serious shortcoming given the fact that the majority of fixed-rate, municipal bond issues are callable and issued with premium coupon rates that make future refinancing highly likely. An improved lifetime cost of capital metric called Refunding Adjusted Yield (RAY) incorporates refinancing probabilities utilizing the issuer’s own refinancing criteria in calculating cost of capital. This new measure offers significant advantages in optimal bond structuring and is a more comprehensive and complete metric for use in decisions involving true capital cost including competitive bid awards.

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Public pensions mostly under control in 800 state and local districts across the US

Alicia H. Munnell, Center for Retirement Research at Boston College
Jean-Pierre Aubry, Center for Retirement Research at Boston College

When it comes to the cost of pensions and other post-retirement employee benefits (OPEB), not at all states are created equal. Though some cities like Detroit have faced serious financial hardship, others have done an excellent job providing reasonable benefits to state workers while also accumulating assets. A new paper from Alicia H. Munnell and Jean-Pierre Aubry at the Center for Retirement Research at Boston College highlights the variation across the states in the financial picture for OPEB. Looking at plans that serve nearly 800 entities—including 50 states, 160 counties, 173 major cities, and 415 school districts—the paper provides the first comprehensive accounting of pension and OPEB liabilities for state and local governments and the fiscal burden that they pose. The analysis finds that, while required pension payments comprise an extraordinarily high percentage of own-source revenues for some entities, most jurisdictions have their costs under control. Six states—Illinois, Connecticut, New Jersey, Hawaii, Kentucky, and Massachusetts—face costs in excess of 20 percent of own-source revenue, but 26 states have costs below 10 percent.

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