Claim Dilution in the Municipal Debt Market

Abstract

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 highlights the issue of bondholder claim dilution and the importance of municipal disclosure of private debt. * The views stated herein are those of the authors and are not necessarily the views of the Federal Reserve Board or the Federal Reserve System. We thank Stephen Paolillo for excellent research assistance.