How Have Municipal Bond Markets Reacted to Pension Reform?

While most municipal analysts view pensions as a minor risk to the municipal debt markets, many state and local government officials express concern that poor pension finances greatly threaten their government’s ability to borrow at affordable r ates. Prior analysis by the Center supports the municipal analysts’ view, finding that pension finances had only a slight impact on state borrowing costs over the 2005 to 2009 period. Since the financial crisis, however, rating agencies have begun to explicitly account for pensions in their methodologies; New Jersey, Illinois, and the City of Dallas were downgraded, in part, due to their pension challenges. On the flip side, just last month, Fitch Ratings revised their outlook for the City of Dallas from “negative” to “stable” based on the City’s recently adopted benefit reforms. Given these recent developments, this brief revisits the earlier analysis to see if state and local borrowing costs have become more sensitive to pensions since the financial crisis. The brief also expands the scope of the analysis in two important ways. First, it includes local governments, whose borrowing costs may be more sensitive due to their smaller and less flexible tax bases. Second, it investigates whether the flurry of reforms made in the wake of the financial crisis have had any impact on bor rowing costs. The discussion proceeds as follows. The first section describes the municipal bond market generally and examines how it has evolved from the turn of the century to today. The second section discusses the current public pension challenge in relation to gov ernment finances and the municipal bond markets.