Municipal Bankruptcy and the Economic Costs of Financial Contagion

Joint project with Lisa Knauer

Paper available upon request

Abstract:

This paper examines whether one municipality’s bankruptcy exposes other local governments to economic costs of financial contagion. To disentangle the bankruptcy’s effect from the general economic trend, we identify idiosyncratic bankruptcies using a narrative approach. We show that non-bankrupt municipalities issue less debt following the bankruptcy. To identify its economic consequences, we exploit ex-ante heterogeneity in local governments’ maturity of long-term debt. We find that high fractions of maturing debt lead to lower government spending and employment, as well as lower tradable employment. Overall, our results suggest that bankruptcy as resolution mechanism deteriorates the development of other municipalities that rely on debt financing.