Single-party dominance in a state has been found to have an effect on local government savings and the yields in the secondary municipal bond market. The recent paper titled “State government trifectas and municipal bond pricing” presented at the Brookings Municipal Finance conference sheds light on this phenomenon. The study was conducted by Angela Gore, Riddha Basu, and Amanda Beck, who analyzed bond prices from 2005 to 2018 to draw their conclusions.
According to the research, when one party gains control of both the state legislature and governor’s seat, there is a modest yet noticeable decrease in the yield spreads on secondary market local government bonds. This reduction in yield spreads ranged from four to 20 basis points, which was deemed economically significant. The impact of state trifectas was also observed in the primary market, where bondholder yields were approximately 2.3 basis points lower.
Currently, there are 23 Republican trifectas, 17 Democratic trifectas, and 10 divided governments in the United States. The increasing number of trifectas shows a trend towards single-party dominance. Researchers also explored how state trifectas interacted with laws that are perceived to increase default risk, such as access to Chapter 9 bankruptcy and restrictions on local tax increases. Interestingly, it was observed that trifectas helped mitigate the risks associated with these policies, particularly in states with Democratic control.
Implications for Bondholders
The study highlights that bondholders are attentive to how party control mediates state laws related to bankruptcy and local tax restrictions. This suggests that political factors play a role in shaping the municipal bond market. Tracy Gordon from the Urban-Brookings Tax Policy Center commended the paper for its insights, emphasizing the importance of understanding the relationship between state politics and bond pricing.
The research on the impact of state trifectas on the municipal bond market provides valuable insights into the dynamics of bond pricing. By examining the interaction between political party dominance and perceived default risks, the study sheds light on the complexities of the municipal bond market. Further research in this area could help investors and policymakers better understand the implications of political factors on bond yields.