MEXICAN BONDS IN A COMPARATIVE PERSPECTIVE

In contrast to Mexico, the exceptional situation of the United States is that autonomous states create their own budget and fiscal rules that meet voter preferences. The defragmented institutional arrangement of the central government—without a central budget authority—allows states and local government managers to create independent rules unique to each state’s situation and tie them to different revenue sources. This robust system allows credit systems and market mechanisms to work independently from budget authorities. The success of the United States shows a limited federal control over state and local borrowing, debt, and finances (Chapter 9 bankruptcy) managing to have virtually no federal bailouts (Laubach 2005; Kincaid 2012). Effectively all states have some sort of balanced budget rules, whether they are statutory and constitutional; related to tax and expenditure limits; or some sort of local bankruptcy/fiscal distress provisions (Spiotto, Acker and Appleby 2012). State variations reflect individual policy decisions and fiscal behavior in the absence of federal bailouts. This is what Rodden (2006) suggests imposes fiscal discipline to the subnational credit markets.

Notably, financial experts suggest that fiscal rules are not automatic for ensuring adequate sub-national fiscal discipline (Ter-Minassian 1997). Fiscal rules are only effective if they are created in democratic systems with sound designs, a robust legal system, based on implementation tools that include firm enforcement mechanisms. Yet meeting all these prerequisites is far from insignificant and flaws can lead to profligate subnational spending. Thus the most important element of fiscal rules is how to constrain public managers from over-consuming the common pool either through off-budget expenditures, investments not tied to assets, or capital enhancements based on expired future revenue streams from the national government. This may happen in the context of public private partnerships, which is currently impending in the Mexican situation.

Historically, empirical evidence in the US for constraining the common pool resource problem of overreaching municipal debt was managed in the intergovernmental system by political constraints of voters. This has been done through balanced budget requirements, tax and expenditure restrictions (TELS) and debt limitations. Von Hagen’s (1991) classic piece explained that the principal-agent of the voter-politician relationship resembles an “incomplete contract” allowing voters and citizens to constrain the electorate would lead to stronger institutions. Von Hagen (1991) found that the effectiveness of fiscal rules is limited at best, because politicians are likely to find ways to circumvent them, such as governor’s veto powers.

International comparative research has evaluated the effectiveness of fiscal rules for federalist or unitary countries and found they work better in the former not the latter (Ter-Minassian, 1997). Also empirical evidence tests the validity of some theoretical considerations developed through economic modeling. For example, Poterba (1994) and Alt and Lowry (1994) find that states with harder balanced-budget rules react more promptly to revenue or spending shocks. Poterba (1994) and von Hagen (1991) find that state budget rules affect the level and composition of state debts. But Bails and Tieslau (2000) suggest there is a conflict in the political science literature between “public choice” and “institutional irrelevance” view for the relevance of state budget institutions. Furthermore, endogeneity issues are tussled throughout this body of empirical literature. The chicken and the egg is whether rules need to be created before institutions or whether strong institutions are needed to create better rules. Finally, other researchers test data to ensure that adequate sub-national fiscal discipline can help prevent sub-national debt crisis. In effect all research seeks to find the appropriate rules to ensure that core design of inter-governmental fiscal arrangements is sustainable and collaborative.

Capital Markets and Bankruptcy in the United States

Capital markets in the United States have grown by exponential rates that are based not on fiscal rules, but on their market mechanisms (ACIR 1987). There is considerable theoretical interest in describing how rational lenders may respond to imperfect information by rationing credit to borrowers (Bayoum, Goldstein and Woglom 1995). Much of this literature identifies credit constraints with a market failure or describes how credit ratings happen outside of formal governmental-institutions.

Recently, however, it has been argued that default credit constraints can play a more positive role in disciplining irresponsible, sovereign borrowers (Bayoumi, Goldstein and Woglom 1995). This more optimistic view, called the market discipline hypothesis, has helped define the debate on the most effective way to restrain subnational governments. An important aspect of the market discipline hypothesis is an assumed nonlinear relationship between yields and debt variables. Advocates of market discipline assume that yields will rise smoothly at an increasing rate with the level of borrowing, thereby providing the borrower with an incentive to restrain excessive borrowing. If these incentives, however, prove ineffective, the credit markets will eventually respond by denying the irresponsible borrower further access to credit, and the irresponsible borrower will be constrained through bankruptcy proceedings.

Yet, bankruptcy is not a solution to every debt problem. Levitin (2012) argues that states’ fiscal problems are generally a structural-political problem that bankruptcy cannot be expected to fix. Accordingly, bankruptcy makes sense only as a political tool, rather than a financial-legal restructuring tool. Bankruptcy is equipped to accomplish political restructuring.  However, it is not a forum in which fiscal federalism can be renegotiated. On the contrary, this is the fiscal space that is most consumed and harmful to the overall economy where the common pool of intergovernmental relations is problematic if not managed effectively.

As a result, very few cities in the United States have declared bankruptcy within and around the time of a financial crisis. Also, this is why the federal government has almost never bailed out local or state governments. While Chapter 9 has been around for many years, some cities (Detroit, New York and now Atlantic City) have had to be bailed out by state governments. Still others have filed for bankruptcy not for taking out too many loans, but as a way to re-negotiate their financial contract with the city public employees and payments to their pension systems (for example Vallejo and San Jose in California). These actions were rational and had little to do with the inter-governmental fiscal balance of the federal government but were more likely to be based on market mechanism.

Finally, the most recent empirical efforts describe how clarity within the rule-making process helps eliminate information asymmetries and allows for market mechanisms to operate at the subnational level (Kelemen and Teo 2014). These authors cite literature that judiciary enforcement mechanisms (i.e. bankruptcy) in the United States and European Union have not meant strong more robust capital markets. Instead, they argue that clarity in fiscal rules is a more effective way of strengthening capital markets. These authors cite Goldstein and Woglom (1992), Bayoumi, Goldstein and Woglom (1995), Poterba and Ruben (1997) and Lawry and Alt (2001) who suggest that bond markets, rather than courts, are more of a deterrent for violations to instill fiscal discipline and punish those who violate fiscal rules. For them, the clarity of rules includes a 1 to 5 measure if a state or local government has the following: 1) budget reported on the General Accepted Accounting Principles; 2) frequency of its budget annual cycle; 3) if the legislature is prohibited from passing open ended appropriations and 4) whether the budget is required to publish performance measures. These elements provide clarity in the budget and the budget process.

Therefore, for Levitin (2012) those authors that argue developing countries must have strong institutions and a robust rule of law with capacity for sanctions in order to have robust capital markets, may be wrong (Velasco 1999; von Hagen 1991). Punitive sanctions for illegal financial transactions by public managers that are difficult to identify, manage and enforce within ever-evolving penal codes may not be imperative. Within these emerging institutional environments, public managers should abide by the institutional rules such as standardized accounting measures, regular auditing procedures with internal/and external control that minimize political influences in order to obtain a high quality rating and cheaper credit. Furthermore, public managers must be knowledgeable about debt financing mechanisms and options within their local markets, like the four types described here for Mexico, when selecting the types of public loans best to serve the public. Finally, public managers need to understand that loans are based on better terms and solid tangible assets, or fees-based structure to be able to pay back their loans within a reasonable time period. Own-source revenues, for example local tax collection efforts or fee-based structures for services, made to payback local loans are fundamental for internal bond markets to be operational.