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Working Paper
Pushing Bonds Over the Edge: Monetary Policy and Municipal Bond Liquidity
We examine the role of institutional investors in monetary policy transmission to asset markets by exploiting a discontinuous threshold in the tax treatment of municipal bonds. As bonds approach the threshold, mutual funds, the primary institutional traders in the market, dispose of the bonds at significant risk of falling below the threshold. This is driven by mutual funds anticipating future illiquidity. Once bonds cross the threshold, their liquidity declines and illiquidity-induced yield spreads increase substantially as retail investors become more important in price formation. ...
Working Paper
Are Concerns About Leveraged ETFs Overblown?
Leveraged and inverse exchange-traded funds (ETFs) have been heavily criticized for exacerbating volatility in financial markets because it is thought that they mechanically rebalance their portfolios in the same direction as contemporaneous returns. We argue that these criticisms are likely exaggerated because they ignore the effects of capital flows on ETF rebalancing demand. Empirically, we find that capital flows substantially reduce the need for ETFs to rebalance when returns are large in magnitude and, therefore, mitigate the potential for these products to amplify volatility. We also ...
Working Paper
The “Privatization” of Municipal Debt
We study the determinants of local governments’ reliance on bank loans using granular data from the Federal Reserve. Governments that are larger, rely on stable revenue sources, or have higher spending relative to revenues are more likely to borrow from banks. About a third of governments in the top revenue quintile have obtained bank loans since 2011, typically accounting for a fifth of their total debt. Declines in revenues, reductions in bond market access, agency rating downgrades, and relationships with financial advisers and underwriters all strongly predict higher bank loan reliance. ...
Working Paper
Financial Condition and Product Market Cooperation
We provide evidence that existing studies relating financial condition to product market cooperation produce mixed results because of unique features of the industries examined. In particular, all evidence suggesting that poor financial condition decreases cooperation comes from the airline industry during periods of high idle capacity. Using a unique data set of aggregate airfare hikes and a more recent low-idle-capacity period, we find that poor financial condition is positively associated with product market cooperation. Although financially weak airlines appear to value the immediate cash ...
Working Paper
Tying loan interest rates to borrowers' CDS spreads
We investigate how the introduction of market-based pricing, the practice of tying loan interest rates to credit default swaps, has affected borrowing costs. We find that CDS-based loans are associated with lower interest rates, both at origination and during the life of the loan. Our results also indicate that banks simplify the covenant structure of market-based pricing loans, suggesting that the decline in the cost of bank debt is explained, at least in part, by a reduction in monitoring costs. Market-based pricing, therefore, besides reducing the cost of bank debt, may also have adverse ...
Working Paper
Gas Guns and Governments: Financial Costs of Anti-ESG Policies
We study how regulation limiting ESG policies distorts financial market outcomes. In 2021 Texas enacted laws that prohibit municipalities from contracting with banks with certain ESG policies, leading to the exit of five of the largest municipal bond underwriters from the state. Issuers previously reliant on these underwriters face higher uncertainty and borrowing costs since the enactment of the laws. These effects are consistent with a deterioration in underwriter competition as issuers face fewer potential underwriters. Texas issuers will incur $300- $500 million in additional interest on ...
Working Paper
Claim Dilution in the Municipal Debt Market
Using loan-level municipal bank lending data, we examine the debt structure of municipalities and its response to exogenous income shocks. We show that small, more indebted, low-income, and medium credit quality counties are particularly reliant on private bank financing. Low income counties are more likely to increase bank debt share after an adverse permanent income shock while high income counties do not shift their debt structure in response. In contrast, only high income counties draw on their credit lines after adverse transitory income shocks. Overall, our paper raises concerns about ...
Discussion Paper
The Impact of Natural Disasters on the Corporate Loan Market
Natural disasters are usually associated with an increase in the demand for credit by both households and companies in the affected regions. However, if capacity constraints preclude banks from meeting the local increase in demand, the banks may reduce lending elsewhere, thus propagating the shock to unaffected areas. In this post, we analyze the corporate loan market and find that banks, particularly those with lower capital, reduce credit provisioning to distant regions unaffected by natural disasters. We also find that shadow banks only partially offset the reduction in bank credit, so ...