Fiscal Imbalances and Borrowing Costs: Evidence from State Investment Losses

Fiscal Imbalances and Borrowing Costs: Evidence from State Investment Losses

By
Robert Novy-Marx, Joshua D. Rauh
American Economic Association. May
2012, Vol. 4, Issue 2, Pages 182-213

During the last quarter of 2008, financial losses in state pension funds varied from 12 percent to 68 percent of the revenue generated by the state government. We quantify a sovereign default channel in the state municipal market by examining how changes in bond spreads vary with state pension fund losses, controlling for credit ratings and various measures of the state’s fiscal strength. Municipal bond spreads rose by 7-15 basis points for each 10 percent of state-generated revenue lost by states in the lower half of the credit quality spectrum.