Municipal Bond Insurance and the U.S. Drinking Water Crisis

Abstract

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. We show that after these products crashed in value in 2007, municipalities that were more reliant on relationships with adversely affected insurers faced higher borrowing costs. These municipalities then reduced their borrowing and scaled 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.