THE IMPACT OF A STATE BOND GUARANTEE ON STATE CREDIT MARKETS AND INDIVIDUAL MUNICIPALITIES: ABSTRACT

This paper examines the overall effect of a state bond guarantee on state credit markets and individual municipalities. We analyze the Texas School Bond Guarantee program and its impact on the borrowing cost of school districts and other municipalities within the state. We found that although the credit enhancement program allowed school districts to receive a tripleA credit rating, their new bond issues sold for a penalty yield of 18 basis points above that of a comparable natural triple-A bond issue. However, school districts did achieve interest cost savings as a result of the guarantee program, ranging from 40 to 98 basis points for bond issues rated singleA and Baa, respectively. School districts whose bond issues were rated double-A or above did not achieve any interest cost savings. Finally, because of the increase in supply of triple-A debt in the Texas municipal bond market caused by the credit enhancement of school district bonds, the borrowing cost of other municipalities who sell their debt in local credit markets increased by 49 basis points. This finding suggests that state officials need to carefully analyze the distributional effects of credit enhancement programs because they can increase the borrowing costs of some municipalities within a state.