Not all state authorizations for municipal bankruptcy are equal: Impact on state borrowing costs

Abstract

This paper investigates the impact of state authorizations of municipal bankruptcy on state government borrowing costs. The credit markets may perceive bankruptcy authorizations as credit enhancing because states signal no implicit guarantee of local debt. However, the markets may charge a risk premium if authorizations could cause strategic uses of bankruptcy, widespread filings, and contagion. Analyses using 1975–1997 state borrowing-cost estimates show that different authorization regimes have differing effects. Specifically, authorizations conditional on state intervention are associated with a reduction in state borrowing cost. Analyses of a 2010 Rhode Island legislation using state bond data provide similar findings.