Association for Public Policy Analysis & Management

As an alternative way to issue bonds, conduit financing (CF) has been widely used by local governments and nonprofit organizations. CF allows one entity to issue debt on behalf of single or multiple borrowers. In the U.S., a local agency is allowed to issue municipal bonds in compliance with law, but can also borrow through a joint powers agency (JPA). In this case, the JPA serves as a conduit. CF is preferred by local agencies in certain circumstances because it is more convenient or fixed issuance costs can be split between several conduit borrowers through bond pooling. Conduit operations, however, bring extra financial and administrative burdens, and conduit borrowers are required to pay a substantial amount of issuance costs. Since most local governments have been burdened with heavy debts, understanding whether or not the CF actually decreased their borrowing costs is very important.

The emergence and existence of this type of conduit is profoundly historical and political.  One reason for this is informational asymmetry in the municipal bond market. The disclosure requirements of the municipal bond market are weaker than the corporate bond market, and plenty of small issuers are less known by municipal bond investors. Although bond pooling provided by conduits is supposed to lower borrowing costs, most bonds issued by JPAs finance a single local agency. Therefore, it is important to investigate the incentives for these local agencies to use conduits instead of arm’s-length investors. As a matter of fact, during the borrowing process, the JPA is a type of financial intermediary that can reorganize small issues more efficiently. Hence, sophisticated local agencies with strong fiscal backgrounds prefer to borrow directly from the credit market under their name. To avoid selection bias, a two-stage selection model will be used. The first stage identifies which local agencies will utilize the direct bond issuing method. That is: what drives local agencies to use conduit? And the second stage examines whether interest and issuance costs are significantly reduced. Importantly, in my work, long- and short-term debts are analyzed separately. Moreover, to my knowledge, there are very few studies that consider the influence of CF on local government borrowing costs. My research, which draws chiefly on data from the California Debt and Investment Advisory Commission (CDIAC), seeks to bridge this gap.