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The Effect of State Solvency on Bank Values and Credit Supply: Evidence from State Pension Cut Legislation

Published online by Cambridge University Press:  12 July 2018

Lee Jeremy Cohen ,
Marcia Millon Cornett ,
Hamid Mehran  and
Hassan Tehranian
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Abstract

We find the financial condition of states impacts bank credit supply through their municipal bond holdings. In particular, we treat sudden political and statutory actions during the 2011 union bargaining rights debates in Wisconsin and Ohio as exogenous shocks to state solvency. We show bank valuations and municipal bond spreads adjust to the announcements, and, over longer horizons, a new lending channel linked to state solvency emerges, whereby banks supply credit as municipal bond appreciations free up capital.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 4 , August 2018 , pp. 1839 - 1870
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

The views expressed are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. The authors thank an anonymous referee, Ozgur Demirtas, Erik Gilje, Stu Gillan, Atul Gupta, Jie (Jack) He, Oguzhan Karakas, Darren Kisgen, Paul Malatesta (the editor), Alan Marcus, Lindsay Mollineaux, Jim Musumeci, Jun Qian, Kristle Romero Cortés, Ronnie Sadka, Phil Strahan, and seminar participants at Boston College, Bentley University, and the Federal Reserve Bank of Atlanta for their helpful comments. An earlier version of this paper has been circulated under the title “The Effect of State Pension Cut Legislation on Bank Values.”

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