We were perplexed by the March market sell-off. Why then? Did it take that amount of time for investors to realize that the virus would be with us for longer than we were originally told? But the drop was so sudden and sharp.  The reason came into focus six months later, when news surfaced (October 14, New York Times) that the president had held a private meeting with senior officials of the Hoover Institution at the end of February.  The purpose of that meeting was to inform them of the serious impact the virus was likely to have on the economy.  Word spread quickly among a network of investors who sold and shorted holdings. Meanwhile, public messaging was that the virus would go away with warmer summer weather.

The Federal Reserve (Fed), fearing an all-out market meltdown, intervened with a plate of lending programs that included the municipal securities market for the first time ever – the Municipal Liquidity Facility, MLF, with an allocation of $500 billion.  Markets calmed down quickly and the Fed declared victory. The Fed also complied with a dramatic drop in interest rates.  This satisfied the President, who, for months had been hounding Fed chair Jerome Powell to lower rates and give the economy a boost.  While the Fed had begun to normalize rates before the pandemic, following years of resistance after the Great Recession, COVID-19 served up a reason to head back to the “zero bound”. 

Moving back to near zero rates has its benefits, particularly in a pandemic stricken economy:

  • Low rates bolster asset prices, whether in housing or financial markets.  This improves the net worth of those who own housing in newly “hot” locations and those with investments in markets. 
  • Low mortgage rates have supported migration from denser urban locations to lower density suburbs and exurbs, away from COVID-19 spread. 
    • Receiving communities benefit from new migrants, with increased economic vitality.  This trend reverses what we saw during and after the Great Recession. Suburban and exurban suburbs lost value when the mortgage bubble burst.  In contrast, parts of major cities are now hollowing out; rental and purchase prices are falling. 
    • Second and third tier cities (by population) have become popular.  Another knock-on effect is that once forgotten rural locations are seeing more economic economic activity. 
  • Low rates benefit the municipal bond market too.  Given the lowest treasury rates seen in decades, many municipalities have found much needed savings by using taxable bonds to refund tax exempt bonds.  In fact, taxable borrowings through Q3 2020 have been $103 billion, comparable to all of last year’s $72 billion (Bond Buyer market data).
  • Money for capital improvement projects (so called “new money”) totaled $189 billion through Q3 2020.  Extrapolating to 12 months is $252 billion, comparable to last year’s $265 billion and the strong 2017 and 2018 years of $203 billion and $235 billion respectively. 

Is Federal help in the wrong place?

The surge in municipal bond offerings does not mean we have solved the problem of aging infrastructure; leaded water pipes, leaky-roofed schools and pot-holed roads.  When we’ve had infrastructure crises in the past, federal government has stepped up.  We cite, for example, the Clean Water and Safe Drinking Water Acts which seeded state revolving funds.  Further back in time the Interstate Highway System was built with the aid of federal money. The Department of Agriculture’s Rural Electrification Administration brought electricity to rural America.

Some senators are miffed that the MLF has been used by only two borrowers: the state of Illinois and the New York Metropolitan Transportation Authority.  The state of New Jersey, undergoing deep cash strain, contemplated using the MLF but has chosen to use public capital markets instead.  If state and local government doesn’t need this help, maybe everything is ok. Right? Wrong.

There are at least three reasons that the program hasn’t been better utilized, none reflecting that life is anything close to normal in the real economy.

  • First, it’s a borrowing program that is due to be paid back over a short period of time.  Last March, when we were told that the virus would not last very long, a short payback period seemed okay.  The MLF was also set up with punitive interest cost, and only for the largest borrowers.  Over time the Federal Reserve has continued to modify conditions in order to encourage more borrowers to utilize the facility. 
  • Second, many state and local governments have borrowing restrictions that make it near impossible to borrow from the MLF.  We name a few:
    • Debt/property limitations
    • Tax limitations
    • Use of proceeds (i.e. capital markets borrowing may not be used for operations)
    • Constitutional and statutory limitations
  • As of October 27, 2020, twenty-two states have already borrowed heavily from Treasury for their share of unemployment insurance (UI).  Despite strained cash flow, they may not be eager to take on more debt.  (This list includes the Virgin Islands, which is already close to the 15% borrowing limit.)  Like the MLF, these are loans, not grants, and must be paid back with interest.  Congress amended the interest a state must pay on its outstanding balance by deferring the accrual until December 31, 2020.  Charging states and employers higher fees during a nascent recovery cannot be wise economic policy. There will likely be state and local budgetary impact in the middle of FY2021 unless Congress takes additional action. 
  • The liquidity crunch will intensify in Q2 2021 when April tax filings reflect high 2020 unemployment, (and this shortfall, by the way, will squeeze the federal government as well).  Liquidity support could be needed by Q2 2021, which suggests that the MLF should be extended from its current termination on December 30, 2020. 

Financial markets vs. the economy

Importantly, a view that the federal government has already solved the problem of state and local government misses some key points.  Those not invested in financial markets nor selling suburban property are experiencing a very different economy.  In yesterday’s Wall Street Journal (possible paywall), Heather Gillers and Gunjan Banerji discussed the major cash crunch among state and local governments.  According to Moody’s Analytics as cited in the article, state budgets could sustain a shortfall of $434 billion over the next two years compared with pre-pandemic levels.  This does not include local government losses nor future pandemic costs to distribute and administer vaccines, modernize technology for remote learning/working or service a second wave of virus cases. 

There is some economic improvement, yes, but federal inaction is leaving many behind, perhaps permanently. The September Bureau of Labor Statistics (BLS) establishment figures show that employment was still down about 10 million year over year.  Elsewhere, a study by the Becker Friedman Institute (BFI) showed that the lowest paid quintile suffered greater employment losses than higher quintiles (see page 11 of the report).

In addition, women were disproportionately affected by COVID-19 employment losses.  In its September Monthly Labor Review, BLS comments “COVID-19 recession is tougher on women”.  First, women tend to be over-represented in customer-facing industries such as retail, hospitality and healthcare.  In previous recessions, more male-dominated sectors like manufacturing and construction were harder hit.  “Second, the coronavirus shutdowns have closed schools and daycare centers around the country, keeping kids at home and making it even harder for parents (especially mothers who tend to provide the majority of childcare) to keep working.” BLS estimated that 15 million single mothers in the U.S. will be the most severely affected.

Recent average hourly wage increases are misleading for these reasons, as BLS and others noted.  The disproportionate loss of the lowest paid from the employment rolls boosts the average, but this analysis alone is indifferent to the economic pain facing the lowest paid unemployed population.  In addition, the absence of affordable and safe child care makes it especially difficult for these women to return to work. Another study, which we mentioned in a July blog post, found that the “replacement rate” of unemployment insurance (UI) exceeded 100% among the lowest paid unemployed.  But authors failed to take into account the issue of closed schools or confidence that crowded workspaces had been made safe.

Despite the fact that this report left out some important factors in the return-to-work decision-making (authors acknowledge that was not the objective of their study), members of the Senate seized on the narrative of the disincentives of UI for people at the lowest income levels. There are undoubtedly numerous examples of people who did not want to return to work while the extra $600 was in place. But that benefit ended over the summer and we now know that early re-opening states have seen surges of the virus. Lack of adequate employer and employee supports cannot be good policy for 15 million single mothers, their children and the economy at large.