The Rise and Fall of the Municipal Swaps and Derivatives Market

Despite coverage in the financial press, government use of derivatives such as interest rate swaps remains an understudied area of public financial management. Indeed, press accounts emphasizing the downside of these transactions are some of the only accounts of their use. Although headlines about millions in termination payments may generate reader interest, they are not systematic evaluations of these instruments. This article provides more information about government use of debt-related derivatives before, during, and after the financial crisis by describing how the largest city and state governments used them over time. It corroborates prior work suggesting a rapid increase in the use of the instruments during the 2000s but shows a precipitous decline in their use at the onset of the financial crisis in 2008. This decline was likely initially driven by market volatility, but it has persisted, perhaps due to shifts in government risk preferences or attitudes toward interest rate swaps.