Municipal Bankruptcy Spillovers

Joint project with Lisa Knauer

Paper available upon request

Abstract:

This paper identifies the debt market as a channel through which bankrupt municipalities impose negative externalities on non-bankrupt municipalities. The bankruptcy of a municipality sends a negative signal to the state’s municipal debt market and leads to financial contagion. Following a bankruptcy, we show that non-bankrupt municipalities with a high share of maturing longterm debt—and therefore with an immediate demand for credit—reduce their public expenditures and experience a decline in private-sector employment. We apply a narrative approach to identify idiosyncratic bankruptcy events. Further, we rule out alternative channels, that is, a direct demand spillover of the bankrupt municipality to other non-bankrupt municipalities, and that differences in municipalities’ observables drive our results.