Where are the Testing Kits, Respirators and Protective Gear?

What is the Defense Production Act (DPA)? Did Trump activate it? You might be surprised that Congress has authorized the DPA 50 times since its enactment during the Truman administration including the latest in March 2018 with authorization through 2025.  So what’s up with that?  This quick read article discusses the answers, with links for those who want source documents or to go deeper.

Taxes, Short-term borrowing and State and Local Government Budgets

With federal tax filings pushed off to July, will states follow suit?  The concern is that maintaining the same April 15 date will “negate much of the benefit of the federal extension” according to the Tax Foundation.  They are tracking which states have extended the filing date alongside the federal postponement.  You can find this information here.

However, with heavy disruption in the short term municipal note and VRDN (variable rate demand notes) markets, issuing notes to make up for planned revenues and bridge the tax filing dates could be costly.  More than $12 billion was withdrawn from municipal mutual market funds both short and long-term in the week ending March 18th.  Municipal money market funds comprised $4.5 billion of withdrawals according to Barron’s. 

In addition, a product called “tender option bonds” (TOBs) was affected by the spike in short-term yields.  Major fund families, such as BlackRock, Nuveen, Invesco and PIMCO unwound about $1.2 billion of TOBs according to Bloomberg.  TOBs are a structure that relies on the difference in yields between short and long term securities. Short-term securities are sold to the public market as variable rate securities while the fund company retains the long-term security.  When short term rates spike, the structure is no longer viable and is particularly troubled when leverage had been used to boost returns.  During the financial crisis in 2008-2009, a similar event happened.  The result was a flood of long term municipal debt in the market, more than investors wanted to absorb, vastly cheapening those securities. 

The Federal Reserve took emergency action this week on the short end of the bond market and permitted the purchase of municipal securities in the “Money Market Mutual Fund Liquidity Facility” including municipal VRDN.  Also, they expanded the Commercial Paper Funding Facility to include high quality municipal bonds. That press release is here.

Another Budget-Buster: The Coming Unemployment Insurance Debacle

Phone lines and applications are already overwhelming unemployment offices and its only been a few weeks since government orders to shut-down all non-essential activities went into place.  The unemployment insurance program is a shared federal/state, employer/employee program with funds kept in each state’s Unemployment Trust.  (FUTA and SUTA — you figure out the acronyms.)  Recent stimulus legislation recognized that requiring a laid-off employee to prove that they are looking for work makes little sense in the time of coronavirus.  Recall that after the Great Recession, several states had to borrow from Treasury to meet their share and some sold bonds.  Failure to repay within a prescribed time frame resulted in higher SUTA rates which pass through to employers — not good for the economy.  California, for example, still had a $1.2 billion loan outstanding as of February 2018 and paid $8.2 million in interest in 2018 according to the Congressional Research Service, CRS.  “Stimulus 3” (as of today, HR 6379 and S3548) hopefully will correct penalties that states pay for “poor experience” and for not paying federal loans on time.

Anyhow, here are links to Congressional Research Service (CRS) report on the Unemployment Trust Fund and State Insolvency (Unemployment Trust Fund CRS RS22954) and a current report on Unemployment Insurance issues for the 116th Congress (CRS unemployment March 16, 2020 report. )

Coming Out of Crisis: Infrastructure and the Municipal Bond Market

While reversal of the lockdowns to prevent spread of the virus may not happen as quickly as Easter, we assume it will happen before too long. As the economy begins to rebuild, people want to continue to have clean, unleaded water, adequate electricity for bandwidth and pothole-free roadways for all the delivery trucks to navigate. By golly, we hope this will not be an intense hurricane season during June-October or that a mutated virus appears for a second attack — but we should think about that as FEMA funds deplete as well.

The need for a fully functioning, smooth municipal bond market is essential to recovering our economic health. In the immediate term, Senator Menendez (D, NJ) proposed an amendment to the Federal Reserve Act to permit the Board of Governors to purchase municipal bonds on the open market during “unusual and exigent circumstances”. (It is S3550 for anyone who wishes to follow.) The Public Finance Network, which consists of 21 state and local government agencies sent a letter to majority and minority leaders of Congress with three basic “asks” to help the market get back on its feet:

  • restoration of advance refunding,
  • greater access for banks to buy small issuer transactions (bank qualified, or BQ), and
  • a return of some version of Build America Bonds — taxable bonds that receive direct payments from the federal government.

Forget about “shovel ready” infrastructure projects that were targeted in 2009. In the healthy market we left behind last month, many public construction projects already in process have come to an abrupt halt. The municipal market has repriced to the point that new borrowing to complete projects or move forward the ones on the drawing board will be more costly than a month ago.

The CRS published an “Insight” comment on March 20, titled “State and Local Fiscal Conditions and Economic Shocks”. The report highlights that

“costs (of capital projects) may increase in recessions due to an increase in the perceived credit risk of state and local government bonds.”

Congressional Research Service #IN11258 March 20, 2020

This is one major reason that the municipal market came to a virtual halt in the last two weeks, short term rates spiked dramatically, virtually no new issues came to market and investors pulled their $12 billion from mutual funds. While Congress is keen on supporting businesses in the new stimulus bill, modern, well-maintained infrastructure is a necessary and essential support for business that is paid for through bonds issued by state and local taxpayers.