Most Governing readers are well aware of the multi-trillion-dollar federal bailouts of large and small companies, which were funded by Congress and implemented through the Treasury Department and the Federal Reserve. But some may not know that the Fed also surgically injected unprecedented liquidity into the municipal bond market. Public officials at the state and local level need to learn how this works and what it portends for a more resilient future in muni finance. Then the opportunity to fully leverage fiscal federalism becomes more obvious.
State bond banks, which consolidate local bond issues to garner better interest rates and lower issuance costs, could supercharge the Fed's municipal-market operations and kickstart local infrastructure projects whenever Congress opens its construction checkbook. But to function as hubs in the intergovernmental finance network, the bond banks would need to expand their charters.
Here's the background: In March, I urged local property-tax collectors to provide leniency to delinquent payers, expecting that most local governments could readily issue tax-anticipation notes to cover cash deficiencies. A local-government finance officer from New Jersey promptly emailed to inform me that his 12,000-population borough just had tried to sell those notes and that there were no buyers. As stocks were plunging, the municipal securities market had frozen. There were simply no bids for many bonds and notes.
Also in March, there was a genuine risk that panicking retail investors cashing out their shares in tax-exempt money-market mutual funds would compel underlying portfolio-securities sales at depressed prices that would "break the buck" and trigger an industry-wide run on the funds. Fortunately the Fed, as the standby lender of last resort, stepped in and provided liquidity. Under a money-market stabilization facility familiar chiefly to industry insiders, the Fed purchased short-term municipal securities, enabling portfolio managers to quietly perform orderly liquidations and preventing the money-market equivalent of a bank run.
But the Fed didn't stop there. It also established a new Municipal Liquidity Facility (MLF) that allows states and the largest cities and counties to backstop 20 percent of their general revenues by borrowing directly from the Fed for up to three years. Please note that key word "largest," because it excludes 99 percent of America's political subdivisions.
For despite all its firepower, the Fed is not set up to buy notes from that New Jersey borough, or from any municipality with less than a quarter-million inhabitants. Nor will it likely ever buy and hold a 30-year infrastructure bond from any municipal issuer, regardless of size. As America's central bank, the Fed is simply not structured to perform such interventions.
But bond banks could be. Right now, there are about a dozen general-purpose bond banks. Many are official state agencies or instrumentalities, while others are joint-powers or inter-local authorities, in some cases affiliated with state municipal leagues. They have functioned for many years as intermediaries and conduits for muni bond issuers within a state, bundling their debt into larger packages that are more attractive to investors.
Such statewide conduit facilities could also connect the Fed and the Treasury with multitudinous localities. It is one thing for these federal entities to interact with 50 state treasurers, but neither has either the interest or the capacity to underwrite, buy, price, service and redeem bonds from 50,000 individual local-government debt issuers. To reach all these subdivisions, they need a go-between — a monetary pumping-station.
Bond banks are well situated to assume that role. Ohio, for example, has a state bond bank for infrastructure projects that might conceivably be repurposed to provide conduit access to the Fed's MLF for all of the state's cities, large and small. Presently, only Cincinnati, Cleveland, Columbus and Toledo meet the Fed's minimum population requirement of 250,000 to access the MLF; Akron, Dayton and smaller cities have been left on the sidelines despite their own pandemic-related revenue shortfalls.
State bond banks also could be a conduit for an existing facility I've previously identified that could become the fast-track lender of first resort for infrastructure projects, organizing the deal flow for everybody: the Treasury's Federal Financing Bank (FFB). If speed to groundbreaking and full employment is a prime objective of a national infrastructure initiative, then the fastest track is for Congress to authorize the FFB to open its window to the states and their bond banks to provide dirt-cheap Treasury-bond interest rates.
Right now, those yields would be less than half those of corresponding AAA/AA tax-exempt munis, and Uncle Sam would collect income taxes on the interest investors receive, making this a fiscal win-win. Congress should enact a one-time trial expansion of this window, to save taxpayer dollars and test the FFB's efficacy as an infrastructure power station.
Even if a congressional infrastructure bill never passes, it still makes good sense to establish a network of state bond banks as eligible counterparties for the Fed's emergency municipal liquidity facilities. Next time, that New Jersey borough could thereby count on a deep pocket for its no-bidders tax notes, with its state bond bank providing access to the Fed's backstop.
State treasurers, financial professional associations, municipal leagues, local-government and school boards, and others looking for quick, affordable financing would be wise to revisit this time-tested innovation with an eye toward an expanded mission in the future. And obviously, somebody needs to speak with the Fed and Treasury staff to sell these concepts upstream. Such an approach would simplify processing for them while enriching their value to the nation.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
