Color and Credit: Race, Regulation, and the Quality of Financial Services

We investigate drivers of financial reform by examining state-level adoption of municipal bankruptcy laws (Chapter 9). To guide empirical work, we present a new model where municipal bankruptcy law destroys labor union rents and expands local firms’ ability to invest. Consistent with theory, we find that the relative strength of unions vis-à-vis bondholders, courts’ efficiency, and trust in local government explain Chapter 9 adoptions over 1980-2012; similar factors explain congressional voting on municipal bankruptcy law; after adoptions, municipal bond spreads decrease, local firms invest more and perform better. Our results highlight a novel spillover channel from public to private sectors.