Why are so many prominent economists making this same plea? On July 15, Dr. Ben Bernanke wrote an Op-ed titled: “I was Chairman of the Federal Reserve. Save the States.” The subtitle: “Congress must act decisively to avoid repeating mistakes of the recovery from the Great Recession”. His main point: state and local balanced budget requirements make their actions during recessions pro-cyclical – that is, they deepen the downward trend with budget cuts, layoffs and furloughs, none of which help recovery.
On July 20th, the Chicago Booth Initiative on Global Markets in collaboration with pollsters FiveThirtyEight published the fifth round of their economic outlook survey. Question 6 asked the panel how they would prioritize $1 trillion for a federal stimulus package “designed to soften the effects of the COVID-19 recession.” The top priority of the nine categories was jobless workers at 39% followed by state and local governments at 36%. In total, 85% of the 33 respondents marked state and local government as one of their top three priorities.
Stated differently, what do we lose from significant state and local budget cuts?
— Public safety, sanitation, modern and safe water systems, paved roads, electric service and broadband transmission systems, infrastructure improvements that buffer communities and save lives from hurricanes, tornados, floods and wildfires, transportation systems that bring goods to your home and workers to their jobs, hospitals, healthcare and welfare services and an educated population ready to meet the next challenge, just to name a few.
To state the obvious, businesses need these services in order to function.
Also in June, the National League of Cities surveyed 1,100 of their members and found:
— 65% of cities are delaying or cancelling capital expenditures and infrastructure projects
— 24% are significantly curtailing community and economic development programs
— 41% imposed or plan to impose hiring freezes and 32% have indicated they will furlough or lay off.
— 70% said their most significant unexpected expenditure was personal protective equipment critical to reopening.
— 70% of cities surveyed had not received CARES Act funding.
The Cares Act gave state and local governments $150 billion to help cover costs of the COVID-19 sudden-stop-shutdown. However, money could only be spent on provable expenditures for the virus – not to make up for the significant loss of revenues due to the same reasons. Now, the Republican Senate’s proposal seeks to “gift” state and local governments with the flexibility to use unspent Coronavirus Relief Funds to meet revenue losses. But most of that money has already been spoken for.
The National Conference of State Legislatures has put together an interactive database on “State Actions on Coronavirus Relief Funds” that is updated daily.
The National League of Cities in partnership with Bloomberg Philanthropies has put together a “COVID-19 Local Action Tracker” that highlights actions each locality has taken to date, in 18 different policy areas.
Timeline: Aside from this week’s termination of the extra unemployment insurance benefits and the lifting of a moratorium on federal housing evictions and foreclosures, other COVID-19 relief packages include end dates of December, 2020. Our view is that the toughest period for states and local governments is likely to come in the first half of 2021, when April tax returns will show the income losses in 2020 and relief funds will be spent.
Market: It is important to distinguish the municipal bond market from infrastructure spending and budget distress. Municipal borrowing in the first half of 2020 was $25.2 billion higher than H1 last year. Post COVID-19, in March-June, the municipal market was up $1.9 billion compared with the same period last year. January and February were strong issuance months while March was down one third from last year when COVID-19 hit. April and May were modestly higher but June jumped 23%. This may have been due to re-opening exuberance and also that construction shut-downs were lifted which may have propelled issuers into the market.
Given the federal reserve’s “lower for longer” approach to interest rates, refinancings were 31% in H1 2020 compared with 25% in H1 2019.
Supply and demand are not broken — investor interest continues and both ETFs and mutual funds are attracting investment. Also of interest is which governments are doing the borrowing:
— States and state agencies are borrowing about the same
— Counties and parishes are down by about 3.3%
— However, cities’ and towns’ borrowings are up by 23%, districts by 26.5% and local authorities by 16%. (Districts encompass school districts and special districts).
— Interestingly, despite major credit concerns about the future shape of higher education, their borrowings were up 165%
— Bank qualified borrowing was up 12%.
Then: During 2008-2009 recession, the federal government authorized $181 billion Build America Bonds, which were issued over a period of 18 months. The bonds were taxable, which opened a new buyer base for municipals and the federal government provided a subsidy to “equalize” the cost to borrowers between taxable and tax exempt bonds. The tax restrictions on AMT or alternative minimum tax bonds were lifted for a period of time. This helped airports, ports, multi-family housing and other sectors come to market. In addition, the limit on “bank qualified” (smaller issuer) borrowing was raised from $10 million to $30 million.
Now: At the beginning of March, 2020, worried about the sudden, violent volatility in the market, the Federal Reserve (FR, or fed) rolled out a series of large liquidity initiatives. The municipal market was included in its program for the first time. Markets calmed down quickly and as members of the FR have repeatedly pointed out, the mere offering of these programs calmed down the market during March. The FR’s goal is to maintain stable markets and for now at least, they achieved this goal. The structure of the program and approach of Treasury and the FR make it seem like less of a liquidity support than temporary market stabilization.
The Municipal Liquidity Facility (MLF) was slow to roll out; some say disputes between the fed and Treasury slowed things down. There have been numerous revisions to open up the program more broadly than just the largest state and local governments. But structural issues remain, making the program difficult to use.
For one thing, unlike the federal government, many state and local governments are not allowed to borrow long term and use the money for operating purposes. For example, there is a dispute (possible pay wall, if so, try this one) about the constitutionality of the New Jersey governor’s nearly $10 billion debt legislation that is heading to the state’s Supreme Court August 5th. The lawsuit concerns the use of long term bond proceeds for operating costs. The legislation in question would also permit the state to borrow from the MLF.
While the FR continues to open up eligibility to different categories of borrowers, the suggestion (not requirement) is that the larger entities will set up their own “special purpose vehicles”, borrow from the MLF and buy notes from their smaller subdivisions. But the larger entities would have to bear 100% of the credit risk. Given the severe fiscal issues at the state and local level due to lost revenues, high unemployment and continuing costs of COVID-19, state and local governments are loathe to take on additional risk.
Finally there’s a penalty interest rate so those that can get lower short term loans in the open market or from bank lenders will go that route.
The program was approved at $500 billion to help with municipal liquidity – Illinois is the only borrower so far at $1.2 billion. Perhaps the rest of this amount could be repurposed for better use.
