The 'Privatization' of Municipal Debt

Abstract

U.S state and local governments are increasingly turning to bank financing amid deteriorating fiscal positions. We document that the maturity and collateral structure of municipal bank loans allows borrowers additional debt capacity by diluting outstanding long-term bonds. Specifically, most municipal bank borrowers obtain loans with shorter maturities than long-term outstanding bonds, also providing municipalities with significant interest cost savings. Last, we show that municipalities substantially increase bank borrowing and decrease municipal bonds issuance in response to exogenous adverse income shocks. This suggests the upward trend in bank borrowing will likely persist if fiscal positions continue to decline.