Calling All Issuers: The Market for Debt Monitoring

Abstract

95% of long-term municipal bonds have callable features, and yet we find new evidence of a substantial fraction of local governments exercising these valuable options sub-optimally, with significant delays – resulting in sizable losses. Using data from 2001 to 2018, we estimate that U.S. municipals lost over $26 billion from delayed refinancing, whereas the entire U.S. corporate sector, facing the same low interest-rate environment, lost only a comparatively modest $1.4 billion. We present evidence that these delays are related to gaps in localized debt monitoring. For instance, when a bond’s call unlocks in a month that is the fiscal year-end of a local government – a particularly busy time for finance departments – the decision to call is delayed significantly longer. A significantly longer delay also occurs when a municipality is faced with waves of calls all coming due at once. These effects are magnified in smaller municipalities, staffed with smaller finance departments. Moreover, the market for outside monitoring (e.g., underwriters), is a fractured one. It is characterized by extreme stickiness: 87% of a municipality’s bonds are issued with the same underwriter over our sample period. The usage of a less locally-focused underwriter is associated with significantly greater delays.

Keywords: Monitoring, State and Local Borrowing, Underwriters, Government Financing

JEL Classification: G10, G12, H11, H74