The Liquidity Crisis: The 2007-2009 Market Impacts on Municipal Securities

This article surveys developments in the municipal debt market for their practical and conceptual implications for public financial managers and scholars. It provides an overview of the market crisis of 2007-9, focusing on what fiscal stress reveals about debt costs, the incidence of risk, and management methods. The first part focuses on the systemic factors-highly leveraged subprime mortgage instruments and collateralized debt obligations-that affected credit availability, interest costs, and the changing risk profiles of the debt instruments. The second part emphasizes the new institutional architecture of the borrowing environment: the collapse of the market for variable-rated securities, the withdrawal from the market of traditional bond insurers, the diminished availability of credit enhancement instruments from banks, the demise of the standby bond purchase agreement, and the introduction of Build America Bonds. The article presents an agenda for practitioners and scholars as they face a borrowing future that differs markedly from that of the past.