The Fed’s new municipal lending powers are not the solution to the massive fiscal problem facing states and cities. That’s up to Congress, and the focus needs to be on overcoming damaging and stubborn Republican opposition to increased state and local aid. State and local governments face a massive revenue shortfall, and more revenue is the answer, not more debt.
WASHINGTON, DC – JUNE 30: Federal Reserve Chair Jerome H. Powell testifies before the House … [+]
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As Congress returns to work this week, they are fighting over budgetary assistance to hard-hit states and cities. That aid remains blocked by Senate Republicans, encouraging Elizabeth Warren and other Democratic Senators to turn to the Federal Reserve, in a letter calling on the Fed to be “a more accessible source of financing” for states and localities.
But having the Fed increase lending to financially strapped governments isn’t the solution. Instead, Congress needs to overcome Republican opposition to state and local funding. State and local governments face a massive revenue shortfall, and more revenue is the answer, not more debt. A new letter from over 130 economic experts once again makes the case for “well-targeted, significant” Congressional aid.
In fact, Senator Warren and her colleagues are largely on the same page as the Fed regarding further Congressional spending. The letter clearly states that “Making it easier for states and municipalities to borrow is not a substitute for Congress providing the (needed) financial support to these governments.”
And the Fed has sent supportive signals on increased Congressional spending. In May, Fed Chairman Jerome Powell, in a CBS
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But if the Fed shares the economic goal of helping state and local governments, why don’t they make their lending programs more generous? There are two basic reasons. First, they don’t believe they have the legal authority to do what Warren is asking. And second, they think their current interventions have stabilized the private municipal finance market.
Until this crisis, the Fed has never intervened in state and local finance markets, fearing political entanglements and being pulled into party and sectional political fights. But in mid-March, the municipal finance market started to seize up. As the pandemic recession took hold, investors began to flee the municipal market, forcing ever-higher interest rates for complex municipal instruments known as Variable Rate Demand Notes (VRDNs). The market then faced an overall liquidity crisis as investors began dumping municipal debt, forcing interest rates ever higher.
Faced with the imploding muni market, the Fed acted within days, supporting financial institutions by allowing state and local debt to be used as loan collateral through the Money Market Mutual Fund Liquidity Facility (MMLF). This prompt action was key to averting the immediate liquidity crisis in the muni market.
In April, the Fed then went a step further, creating a new Municipal Liquidity Facility (MLF) (the various letters can be confusing). For the first time, the Fed would buy state and municipal debt directly. But governments using the MLF have to pay a “penalty rate” above market rates and most of them instead returned to the now-stabilized private municipal market.
From the Fed’s standpoint, the MLF has worked well. It has hardly been used, but the private market has settled down, and most governments are borrowing there at non-exorbitant rates.
It is important to understand that the Fed justifies these actions under its existing legal authority—specifically, section 13 (3) of the Federal Reserve Act. This authorizes the central bank to act in “unusual and exigent circumstances,” and is the legal basis for several Fed interventions, including acting during the muni market’s liquidity crisis. In April’s CARES Act, Congress authorized the Treasury Department to support several new Fed actions, including the MLF.
Critics say the Fed should make the MLF more generous and easier for governments to use. The MLF currently will only buy short-term municipal debt with no more than a three-year term, at above market rates. But advocates say that if the Fed would take on long term municipal debt and lower interest costs, it could reduce repayment burdens on governments, even effectively turning the debt into grants by creating repayment periods up to 100 years or taking other steps.
Warren’s letter goes in this direction. It explicitly asks the Fed to consider “extending the duration and interest rates of the loans to at least match the generosity you have provided…to businesses that are of even poorer credit quality than the municipal borrowers.” Warren and many progressives are appropriately critical of other Fed actions, which helped secure generous financing for companies like Boeing
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In June, Senator Catherine Cortez Masto (D-NV), one of the letter’s signatories, asked Chairman Powell directly at a Senate Banking Committee hearing about making MLF loans “more like a grant.” He rejected the idea, saying “No. We can’t make grants…the law is extremely clear on that.”
So the Fed doesn’t think it has the legal authority to do what Warren’s letter asks. And the current low rates and available credit in the municipal finance market makes them feel the MLF and other actions have succeeded. A stable private market with low rates for borrowers is just fine from the central bank’s standpoint.
The Fed is understandably leery of further involvement with the muni market, made up of thousands of separate government issuers, each operating under a different set of legal rules, constitutional restrictions on deficit financing and other barriers. Of course, if the muni market heads south again, the Fed could act under its “unusual and exigent circumstances” powers.
Kent Hiteshew, the municipal finance expert and banker now serving in the Office of Financial Stability at the Board of Governors of the Federal Reserve, recently reaffirmed this. At July’s Brookings Institution municipal finance conference, he said “if additional intervention is required, the Fed’s prepared to consider it,” noting the “huge lost revenue problem” facing states and locals.
But there’s no real news in that statement—by all indications, the Fed thinks the municipal market is working well, and sees no need for further intervention. And so far, they’re right.
State and local governments need cash, not more debt. The massive fiscal problem caused by the pandemic recession continues to drive revenues down, threatening more layoffs and reduced public services, especially with the looming crisis in reopening K-12 education. Senator Warren and her colleagues are correctly concerned about the threats to municipal finance, which could cause a collapse in vital services from police to garbage collection to K-12 education.
As her letter spells out, that means more pain—lost jobs, poor public services— will fall on the most vulnerable, especially Blacks and other minorities who disproportionately live in poor cities and are employed in the public and nonprofit sectors. And major government job losses also will make the recession worse.
Of course, if Congress wants to amend the Federal Reserve Act and give the Fed new responsibilities and powers, they can take that up in legislation. But it would be virtually impossible to pass. Instead, Senator Warren and her colleagues need to keep fighting the good fight to get more direct government aid, echoing the House, which already has authorized close to $1 trillion.
The Fed’s new municipal lending powers are not the solution to the massive fiscal problem facing states and cities. That’s up to Congress, and the focus needs to be on overcoming damaging and stubborn Republican opposition to increased state and local aid.
Note: an earlier version of this blog had an incorrect title for Kent Hiteshew, the title in this version is correct.