View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

November 2019, EB19-11

Economic Brief

Linking Municipal Defaults to Inward Migrations
By Grey Gordon, Pablo A. Guerron-Quintana, and David A. Price

Not all municipal defaults are created alike. Many follow local bust periods —
yet some follow local booms. This Economic Brief presents research linking
both bust defaults and boom defaults to the overborrowing incentives created by migration into a municipality. The research also analyzes several possible changes in the policy and financial environments and finds only modest
predicted effects from eliminating state-imposed borrowing limits, making
certain bailouts available, or increasing interest rates to early 1990s levels.
For municipalities, as for households, heavy
borrowing can lead to financial distress — and,
in the worst case, to default and eventual bankruptcy. While a municipality in default generally cannot have its assets seized, the practical
consequences can nonetheless be serious,
including employee layoffs, deferral of payments
to vendors or to employee retirement accounts,
and cutbacks in services. A municipality with an
untenable debt burden may even be taken over
by an emergency manager or control board, as
in the cases of Flint, Michigan, in 2011 and Washington, DC, in 1995. From 1970 through 2012,
some seventy-three municipalities defaulted on
Moody’s-rated bonds.1
Many instances of municipal overborrowing
and default follow a familiar and intuitive pattern in which the municipality suffers a drop
in population or personal incomes, causing
the tax base to decline faster than the cost of
services — a “bust” default. Such a shift may be
accompanied by a drop in productivity in the

EB19-11 – Federal Reserve Bank of Richmond

area, possibly reflecting the departure of highproductivity jobs and companies. But there is
also a surprising alternative pattern, the “boom”
default, in which default is preceded by a population or productivity boom. Two of the authors
of this brief, Gordon and Guerron-Quintana,
have developed a model to explain the puzzling existence of boom defaults, one that gives
a pivotal role to inward migration; they have
found support for their model in data on past
municipal defaults.2
Looking at Defaults, Boom and Bust
In an effort to isolate some generalities, or stylized facts, about municipal default, the researchers began by considering eight municipalities
that served as case studies of financial distress:
Chicago, Illinois; Detroit, Michigan; Flint, Michigan; Harrisburg, Pennsylvania; Hartford, Connecticut; San Bernardino County, California;
Stockton, California; and Vallejo, California. Four
of the cities — Chicago, Detroit, Flint, and Hartford — had followed the expected pattern in

Page 1

which their populations declined during the period
leading up to their defaults. Four municipalities —
Detroit, Flint, Stockton, and San Bernardino — had
followed the expected pattern in which productivity declined during the period leading up to their
Yet some municipalities in the group exhibited quite
different patterns regarding population, productivity,
or both. San Bernardino, Stockton, and Vallejo all saw
significant population growth leading up to their defaults. For instance, the population of San Bernardino
increased 4.3 percent over the five years leading up
to its bankruptcy declaration in 2012. (The population of Harrisburg remained stable.) Chicago, Hartford, and Vallejo saw large productivity gains during
their predefault periods. Gordon and Guerron-Quintana label such cases “boom” defaults.
What united these municipalities was, of course, high
debt levels. While the average U.S. city owed less
than $1,000 per resident in 2011, Chicago and Detroit owed about $8,000 and $12,000, respectively. In
some instances, policymakers took steps to move a
city’s debt off of its balance sheet as a formal matter;
for example, Harrisburg sold an incinerator project
to a municipal authority while also guaranteeing the
debt issued by the authority, thus remaining responsible in reality.
Modeling Municipal Borrowing
In Gordon and Guerron-Quintana’s model, municipal
policymakers seek to maximize the welfare of current residents. This motivation means that a flow of
migration from other areas into the municipality acts
as an externality that will tend to lead policymakers
to borrow more: current residents will benefit in the
short term from the projects funded by the debt,
but those residents will not bear the full burden of
repayment — the debt will be repaid by both current
residents and future arrivals. A positive shock that
causes a greater flow of in-migration will therefore
create an incentive for policymakers to borrow more.
For the regressions with which they test their model,
Gordon and Guerron-Quintana use Census Bureau

data to calculate county-by-county measures of
population, migration, interest rates, debt, government spending, and productivity. Their regression
results support their theoretical model in which a
shrinking population leads to a bust default, while
in-migration during booms creates an incentive for
overborrowing, leaving the boom city overleveraged and vulnerable to negative shocks. (See
Figure 1 on the following page.)
The researchers then use the model to analyze the
likely effects of several potential changes to the policy environment or financial environment. The first
is eliminating state-imposed borrowing limits, which
exist in many states to constrain local government
borrowing — probably reflecting an intuition on
the part of state policymakers that localities would
tend to overborrow under some conditions if left to
their own devices. Such limits are commonly based
on a percentage of assessed property valuations,
although California is a notable exception in tying its
limit to local indebtedness and revenues. Data from
California and Michigan indicated that municipalities
in both states were generally close to the legal limit
of their indebtedness, suggesting that many were
borrowing as much as they legally could. To help
determine how important borrowing limits were for
restraining debt and default, the researchers analyze
the counterfactual scenario of no borrowing limits.
They find that eliminating the limits probably would
have little effect because private credit markets constrain municipal borrowing almost as much as the
state-imposed rules.
Another change that Gordon and Guerron-Quintana test is making bailouts available to distressed
municipalities — specifically, the smallest bailouts
adequate to avoid default. Consistent with the view
that anticipated bailouts create moral hazard, in
much the same manner that the expectation of
a bailout may reduce the self-discipline of private
financial institutions in taking on risk,3 they find that
the availability of minimal bailouts to municipalities
doubles the occurrence of default. The effect is not
larger, they conclude, because municipal policymakers should be indifferent between a minimal

Page 2

bailout and default and because either option is
costly to residents. However, the results could be
very different if bailouts were significantly more
attractive to residents.

Gordon and Guerron-Quintana conclude by suggesting that their model for analysis of municipalities also should be useful for analyzing the policies
of state and national governments. In their view, a
drastic population flight from Puerto Rico, a population decline in Greece, and a large in-migration
to Spain are instances in which their model may
prove instructive.

Finally, the researchers analyze the effect of increasing municipal bond interest rates — namely, raising
the nominal interest rate on top-rated municipal
bonds from 4 percent (its value in 2010) to 6.5 percent (its value in the early 1990s). They find that
costlier debt induces local governments to reduce
municipal debt per person by an average of 16 percent. At the same time, the higher cost of debt service modestly accelerates migration out of highdebt, low-productivity cities. The effect in terms of
cost per taxpayer of moving between these interest
rates is minor, however, and thus the effect overall
is also minor. In principle, this result implies that
a financially equivalent change in the tax-exempt
treatment of municipal bonds also would have only
minor effects, though the researchers did not separately evaluate such a change.

Pablo A. Guerron-Quintana is an associate professor
in the Economics Department at Boston College.
Grey Gordon is a senior economist and David A. Price
is senior editor in the Research Department at the
Federal Reserve Bank of Richmond.

 oody’s Investors Service, “U.S. Municipal Bond Defaults and
Recoveries, 1970–2012,” May 7, 2013. This figure likely understates the actual occurrence of municipal default in that it is
limited to rated bonds. For both rated bonds and nonrated
bonds, the New York Fed has calculated that a total of 2,521
defaults occurred during the same period. See Jason Appleson, Eric Parsons, and Andrew F. Haughwout, “The Untold

Figure 1: In-Migration and Income before and after Municipal Default






Annual Income in Thousands


Percent of Population









-10 -9
-9 -8
-8 -7
-7 -6
-6 -5
-5 -4
-4 -3
-3 -2
-2 -1
-1 00







-10 -9
-9 -8
-8 -7
-7 -6
-6 -5
-5 -4
-4 -3
-3 -2
-2 -1
-1 00

Bust default







Average default

Boom DefaultBust default


Average default

Sources: Grey Gordon and Pablo A. Guerron-Quintana, “On Regional Borrowing, Default, and Migration,” Federal Reserve Bank of Richmond
Working Paper No. 19-04, February 7, 2019.
Notes: Charts show changes before and after a municipal default event (0 = year of default). The in-migration rate is the annual rate
of out-of-county migrants moving into the county as a percentage of the county’s population.

Page 3

Story of Municipal Bond Defaults,” Federal Reserve Bank of
New York Liberty Street Economics blog, August 15, 2012.

Grey Gordon and Pablo A. Guerron-Quintana, “On Regional
Borrowing, Default, and Migration,” Federal Reserve Bank of
Richmond Working Paper No. 19-04, February 7, 2019.


 rantxa Jarque and David A. Price, “Living Wills: A Tool for
Curbing Too Big to Fail,” Federal Reserve Bank of Richmond
Economic Quarterly, First Quarter 2015, vol. 101, no. 1,
pp. 77–94.

This article may be photocopied or reprinted in its
entirety. Please credit the authors, source, and the
Federal Reserve Bank of Richmond and include the
italicized statement below.
Views expressed in this article are those of the authors
and not necessarily those of the Federal Reserve Bank
of Richmond or the Federal Reserve System.

Richmond Baltimore Charlotte

Page 4