University Study Finds Racial Discrimination in the Municipal Bond Market

A new study from researchers at Duke University, Northeastern University, and Breckinridge Capital Advisors finds that the U.S. municipal bond market does not consider physical climate risks when deciding where to invest, but it generally requires higher interest payments from predominantly Black communities seeking to borrow.

States, cities, counties, and other governmental entities rely on the $4 trillion municipal bond market to help fund essential infrastructure and services, such as schools, roads, and water and sewer systems. Bond issuers repay investors through taxes or fees collected within their service areas. How much investors charge borrowers in interest depends on their perception of each service area’s unique environmental, economic, or demographic risks.

When adjusting for both bond structure and other service area characteristics, the analysis found that communities with majority Black residents face larger credit spreads on municipal bonds than communities with non-Black majorities. Applying this borrowing penalty to the entire municipal bond market results in Black Americans paying an estimated $900 million in additional interest costs each year. In contrast, no statistically meaningful penalty emerged from the analysis for climate risk. All other factors being held equal, communities at higher risk from climate effects, such as sea level rise or wildfires, pay roughly the same rate as lower-risk communities to issue debt for needed infrastructure improvements.

“The results of our study point to mispricing of risk in the municipal bond market — climate risk should matter to investors, but the racial makeup of communities should not,” said lead author Erika Smull, a 2022 Ph.D. graduate of the Nicholas School of the Environment at Duke University who now works as a research analyst at Breckinridge Capital Advisors. “Our analysis shows that climate risk is not priced, but that a ‘Black Tax’ exists in the market. That is problematic for a country that has to grapple with both increasing climate risks and racial disparities.”

The full study, “Climate, Race, and the Cost of Capital in the Municipal Bond Market,” was published on PLOS ONE. It is available here.

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