The Price of Safety: The Evolution of Municipal Bond Insurance Value
(with Kimberly Cornaggia and Giang Nguyen)
Accepted October 2022 at Management Science
Draft left available here until in pressMay 13, 2020 draft at SSRNHutchins Center at Brookings Institute Working PaperBloomberg article: "Cities are Buying Bond Insurance That May Be Giving Them Nothing"
by Martin BraunAbstract
We examine the benefits of bond insurance to taxpayers using comprehensive data over three decades. We employ multiple modelling approaches to account for the selection into insurance parametrically and non-parametrically. Controlling for fundamentals and the choice to insure, insurers with Aaa credit ratings provided valuable coverage in gross terms, on average, prior to 2008. After 2008, insurers were downgraded and municipalities systematically upgraded, shrinking their difference in ratings-based credit quality and thus diminishing the value of credit enhancement. However, average values belie significant heterogeneity. We find no evidence that insurance provided significant value, even in gross terms, to the highest-rated issuers even before 2008. In contrast, we find significant insurance value among lower-rated issuers over the entire period. We conclude that higher-rated communities historically subsidized those with weaker ratings. Cross-sectional results suggest that agency problems and conflicts of interest help explain this over-insurance phenomenon.