The U.S. municipal-bond market is going down a risky road. The debate over ESG investing has so far focused on publicly listed corporate equities, but participants in other capital markets have also expressed interest in socially responsible asset management. The U.S. municipal-bond market, for one, has seen a lot of ESG activity. Unfortunately, much of this activity ranges from dubious to dangerous.

The municipal market's trade publication, the Bond Buyer, has provided extensive coverage of ESG and routinely includes an ESG panel at its conferences. Indeed, last year's California Bond Buyer Conference had two ESG panels. Incumbent data and analytical firms in the municipal market have been adding ESG-related content to their services, and start-up firms are creating new ESG datasets for municipal investors.

Likewise, dozens of municipal-bond issuers are obtaining green certifications for their bonds. The Washington Metropolitan Transportation Authority (WMATA), for instance, which operates subway and bus service around the nation's capital, just sold its second issue of climate bonds. The criteria for such green bonds are set forth by the Climate Bonds Initiative and must be reviewed by an approved verifier.

In its report, WMATA's verifier, Kestrel Verifiers, observed that:

Projects to be financed by the Series 2023A Bonds are diverse, and all directly support the safety, state of good repair, availability and maintenance of a modern public transportation system with low carbon emissions.

These are attributes of pretty much any bond issued by a U.S. transit agency, so it is difficult to understand what value is conveyed by this certification. Kestrel's disclaimer notes that its opinion is based on the information that was provided by the Authority or made publicly available by the Authority and goes on to state:

We have relied on information obtained from sources believed to be reliable, and assumed the information to be accurate and complete. However, Kestrel Verifiers can make no warranty, express or implied, nor can we guarantee the accuracy, comprehensive nature, merchantability, or fitness for a particular purpose of the information we were provided or obtained.

Another climate-bond issuer is the ski-resort town of Park City, Utah. The city sold a total of $142 million in water bonds in 2020 and 2021, each carrying the climate-bond certification and an attestation from Kestrel Verifiers. The main use of the bond proceeds is to build a new water-purification facility, something cities also commonly did before green-bond certifications existed. Among the reasons given for certifying the bonds is that the treatment plant aligns with the U.N.'s sustainable development goal to achieve universal and equitable access to safe and affordable drinking water for all – a purpose that is de rigueur for any municipal water-treatment project.

Park City, with a resident population of 8,619, has six employees working on environmental sustainability. This team is dedicated to making the city net zero by 2030. The city states on its website: We know we can't solve the climate crisis alone. This is an understatement, given Park City's negligible contribution to global greenhouse-gas emissions. Fortunately, Summit County (population: 43,000) which overlies Park City, also has a sustainability office of its own.

Governments overseeing tourist destinations catering to affluent skiers may collect enough revenue from hotel occupancy taxes to cover the costs of climate-bond certifications and sustainability professionals. But other local governments have ESG strategies that are more dangerous.

Across the bay from San Francisco, three local governments are working to establish a publicly owned bank. The proposed institution, the Public Bank of the East Bay, will support deeply affordable housing, . . . address climate change now, and . . . create equity and economic justice. The three cities partnering to stand up this public bank are Berkeley, Oakland, and Richmond. The latter two of these cities are economically stressed: In its ranking of 431 California cities, the state auditor reports that Richmond and Oakland are the tenth and eleventh highest-risk cities, respectively.

Together, the three cities would invest a portion of their liquid assets to capitalize the bank, which would then issue bonds and take deposits to fund lending activity focused on its environmental, social and governance priorities. Because these loans would likely be underwritten on the basis of nonfinancial considerations, they would likely suffer high default rates potentially destroying the capital contributed by the founding cities. To the extent that these cities purchase the bank's bonds and make non-FDIC-insured deposits into the institution, they will also be subject to substantial risk.

The United Kingdom offers a cautionary tale about this type of municipal ESG activity. Thurrock council, which oversees a borough east of London (population: 176,000), began investing in solar farms in 2016. Solar farms are large collections of solar panels that can generate substantial amounts of electricity under proper weather conditions. Ultimately, the council lent $779 million to entities that owned and operated 53 such installations across the United Kingdom.

But the investment did not work out. Toucan Energy Holdings 1 Ltd. went into administration (the British equivalent of municipal bankruptcy) before it could repay the loans. Media accounts suggest that the council did not correctly assess the value of the solar farms and hints at corruption on the part of both the council and the solar-farm owner.

Another often-overlooked factor is the U.K.'s relative lack of sunlight. California and other southwestern states receive about double the solar radiation received by the U.K. It may be that regardless of management factors, the U.K. is simply not a good location for solar parks.

Toucan's default has contributed to a financial crisis in Thurrock. Financial management has been transferred to the overlying county government, a large tax hike has been imposed, and the council is currently seeking a large bailout from the national government.

If the Northern California cities follow Thurrock's lead by borrowing to fund poorly underwritten investments, they might also find themselves following nearby Vallejo and Stockton into the ranks of Chapter 9 bankruptcy filers.

Marc Joffe is a policy analyst at the Cato Institute focusing on state policy issues.