The Impact of Pensions on State Borrowing Costs

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State and local officials have been intensely focused on improving the funding status of their pension plans since the economic downturn of 2008. Officials recognize the importance of strengthening pension assets, not only because of their obligations to employees and retirees, but also because they want to retain good bond ratings.

The winter of 2010-2011 was marked by unsubstantiated claims that state and local governments might default on their municipal bond obligations, causing municipal bond interest rates to rise as individual investors fled the bond market. This brief examines the effect of pension funding on borrowing costs and bond ratings. Key findings include:

  • Both public pensions and municipal bonds are in the headlines.
  • An important question is how pensions affect municipal bond rates. The analysis of 37,500 bond issues found that pension funding raises rates by a modest 3 to 7 basis points. However, if pension costs rise as a share of state budgets, this impact could increase in the future.
  • Pension funding does not have a statistically significant effect on bond ratings.
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