Does Default Stay Local? State Default and City Credit in the 1840s

In 1843 the federal government refused to take over the debts of American states that had stopped paying their creditors, leaving each state to stand on its own credit. This paper asks whether a state’s default also raised borrowing costs for the cities inside it. Using weekly bond prices from the 1830s to the 1850s, I compare the yields on city bonds with the yields on their own state’s bonds. When Pennsylvania defaulted, its borrowing costs rose but those of Philadelphia and Pittsburgh did not: the gap between Pennsylvania and Philadelphia widened by about 1.2 percentage points, all of it from the state’s side, and Pittsburgh traded well below the state as well. In Ohio, which never defaulted, Cincinnati and the state traded at nearly the same yield. At the state level, Pennsylvania’s premium over Ohio was about 2 percentage points, much smaller than a standard calculation suggests. The results show that investors in the 1840s judged each government on its own finances rather than on where it was located. Code and replication files: https://github.com/ames943/does-default-stay-local