We show that the collapse of the municipal bond insurance industry plays an important, but previously overlooked, role in driving regional variation in U.S. drinking water pollution. Public water infrastructure has traditionally been financed using municipal debt partly backed by a small number of monoline insurers. Starting in the 1990’s, some - but not all - of these insurers began insuring structured financial products unrelated to water infrastructure. After these products crashed in value in 2007, several bond insurers ceased to insure new debt issues. We show that municipalities that were previously more reliant on relationships with adversely affected insurers subsequently face higher borrowing costs. These municipalities then reduce their borrowing and scale back investments in water infrastructure, leading to increased water pollution. The data suggest that market failures in the municipal bond insurance industry explain 32% of the relative rise in U.S. drinking water pollution since 2007.
Financial Markets Group Discussion Papers DP 846
Paul Woolley Centre Discussion Papers No 85