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This is THE INDICATOR FROM PLANET MONEY. I'm Darian Woods.

And I'm Wailin Wong. And I hope everyone packed their galoshes today because we have to wade into the culture wars.

WOODS: Oh yeah, it is thick and deep, this morass. But don't worry, there is an economic lesson here.

WONG: And we're going to find it. Now, there's been a lot of public rhetoric from government officials who have attacked companies over their ESG policies. ESG stands for environmental, social and governance, and it's a broad term to describe business decisions around things like climate change and workplace diversity.

WOODS: And some states have gone a step beyond anti-ESG rhetoric. Last year, Texas banned local governments from working with certain banks. These were banks that the state leaders said were discriminating against things like oil and gas and guns. Here's how one state legislator, Republican Phil King, put it.

PHIL KING: If you boycott Texas Energy, then Texas will boycott you.

WOODS: You can't fire me. I quit.

WONG: I'm breaking up with you first.

WOODS: Got that kind of vibe to it.

WONG: Now, when these laws took effect, five major banks stopped working with local governments on municipal bond deals. And this turn of events caught the attention of economist Dan Garrett, who studies the muni-bond market.

DAN GARRETT: The question in my head was what happens when a bunch of banks leave all at once?

WOODS: On today's show, we will follow Dan's efforts to quantify the cost of these anti-ESG regulations in Texas. And we look at what that could mean for other states considering similar moves.

WONG: I got my safety goggles on. Umbrellas up.

WOODS: As we wade, we will find heated rhetoric.

WOODS: A lot of strong opinions.

WOODS: And that's all you need.

WONG: Dan Garrett is super into municipal bonds. And he admits, within his professional circles, there's not a lot of people who share his passion. Not even at the University of Pennsylvania, where he's an assistant professor at the Wharton School.

GARRETT: Anytime someone will listen to me talk about muni-bonds, I get really excited. The bonds are often what we think of as bespoke. It's a really interesting market.

WOODS: Yeah, like bespoke as in, you know, handcrafted, single-origin municipal bonds.

WONG: They're very artisanal. They're so fancy. Yeah. So muni-bonds are highly customized for local projects, like building a new gymnasium for a public high school or spraying chemicals to kill mosquitoes. Glamorous. Very glamorous.

GARRETT: Bonds pay for everything in the U.S. They pay for water treatment. They pay for schools. They pay for sidewalks, public lighting.

WONG: And when local governments issue bonds, they hire banks to underwrite these deals. Let's say a school district is raising $10 million for a new gym. The bank writes the school district a check for $10 million. Then the bank opens up its enormous Rolodex and starts making sales calls. It sells those $10 million of muni-bonds to pension funds and other investors.

WOODS: In Texas, local governments issue about $50 billion in muni-bonds a year. It's a huge market. And now with the new anti-ESG laws in the state, banks are banned from underwriting these deals if, in their other dealings, they had divested from the oil and gas sector or if they had restricted their business with gun companies. This is something that several banks did in response to mass shootings.

WONG: Earlier this year, Dan Garrett was chatting with a fellow muni-bond enthusiast, Ivan Ivanov, when the anti-ESG laws in Texas came up.

GARRETT: We got to talking and Ivan told me, hey, did you see this Texas thing?

WONG: This Texas thing was not just the laws themselves, but what happened after the laws took effect. Five major banks abruptly exited the Texas market for muni-bonds.

IVAN IVANOV: We basically thought that this is a really cool economic shock.

WOODS: A really cool economic shock. Did you hear that?

WONG: Ivan is an economist at the Federal Reserve Bank of Chicago. And oh, we should say he was quick to say in our conversation...

IVANOV: It's my own views. It's not those of the Fed or the board or the Federal Reserve Bank of Chicago.

WOODS: Ivan points out that the departure of these banks was an economic shock because they were responsible for underwriting about one in three muni-bond deals in Texas.

WONG: And these were household names, too - Citigroup, J.P. Morgan Chase, Goldman Sachs, Bank of America and Fidelity Capital Markets. Ivan says having this many big players leave so quickly is a rare event in the banking industry. It left a big hole in the market, and it handed him and Dan this natural experiment on a silver platter.

IVANOV: These laws happened very fast, which for us is very good because the shock is very clean.

WOODS: Dan and Ivan collected data on muni-bonds issued in Texas during that first eight months that those anti-ESG laws were in effect. And they looked at how much it cost for local governments to borrow that money, basically, what they're paying in interest.

WONG: How much a government pays in interest is set in a couple different ways. Sometimes the government chooses a bank, and the two sides negotiate the terms of the bond.

WOODS: And other times the borrower, in this case the government, holds an auction. Different banks submit bids, and whichever bank offers the best terms gets to be the underwriter of the bond. Either way, the final interest rate reflects both the credit worthiness of the borrower and some profit for the bank.

WONG: Dan and Ivan crunched the numbers for eight months of muni-bond deals. And they found that borrowing costs went up when these five banks left the market. They estimate that Texas borrowers will end up paying 300 to 500 million dollars more in interest as a result.

WOODS: There's a couple of reasons why interest rates might have gone up. One is that the big banks have these extensive customer networks that buy muni-bonds. So local governments lost access to these big pools of demand and that made rates go up.

WONG: Another reason might be that with fewer banks in the market, the remaining banks had less competition and therefore more wiggle room to charge higher rates.

WOODS: Dan and Ivan wanted to make sure there weren't other reasons for the higher interest rates, so they set up some control groups. They looked at borrowers in Texas who worked with banks that stayed in the market. They looked at borrowers in other states who worked with the five banks that left Texas. And things got pretty economic-y.

GARRETT: We do what we call a triple difference analysis. So instead of a difference in differences, it's a difference in difference in differences.

WOODS: I love a good difference in difference in differences.

WONG: Can you say it three times fast?

WOODS: Yeah. And then a ghost of John Maynard Keynes will appear, though.

WONG: Oh, no (laughter). Well, we'll leave the statistical analysis and the ghost hunting to Dan and Ivan. Suffice to say, they concluded that the departure of these banks led to the big increase in borrowing costs for the issuers, the local governments.

GARRETT: These issuers who in Texas worked with these specific underwriters experienced an increase in borrowing costs that other issuers in Texas who are similar looking, or outside of Texas who are similar looking, did not experience. Something happened to these specific issuers in Texas starting on September 1.

WOODS: Something happened. Something happened. But what?

WONG: The ghost of John Maynard Keynes?

WOODS: Yeah. Either that, or it might have been the anti-ESG laws which went into effect on that day. Dan and Ivan say what happened with borrowing costs in Texas when they rose up, that could also have an elsewhere. Anti-ESG laws have popped up in states like Oklahoma and West Virginia.

IVANOV: There's, like, 14 more states that have been working on laws that are in the same vein. So it would be nice to see how these other laws impact the markets in those states.

WONG: At the same time, banks are increasingly adopting ESG-related policies. And Dan says this conflict over ESG policies raises the question, who needs whom more? Do the governments need the banks in the market to keep their borrowing costs low? Or do the banks need the underwriting business that they get from states like Texas?

WOODS: And in Texas, it seems like the banks want to come back in. A couple of banks that had left are finding ways to reenter the market.

WONG: And if business resumes as normal, the spike in borrowing costs might be just a temporary blip. Either way, Dan is excited to see what happens.

GARRETT: It's a fun day to do muni-bonds, and I wish we had all the answers for you. That is the nature of research. That's what keeps it fun.

WONG: Keep your goggles on.

WOODS: I'm going to keep my galoshes on. I call them gumboots, though.

WOODS: Not to be confused with gumshoes.

WONG: That's what Dan and Ivan do. They solve economic mysteries.

WONG: By the way, Fidelity, Goldman Sachs and Bank of America are financial supporters of NPR. This episode was produced by Niki Willette (ph) with engineering by Maggie Luther. Senior producer Viet Le also checked the facts. Kate Concannon edits the show. And THE INDICATOR is a production of NPR.

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