Stimulus bond fix may boost local governments more than cash

Provision allows Fed to buy municipal bonds, and advocates say that could restart market flattened by crisis

Sen. Bob Menendez, D-N.J., center, and Sen. David Perdue, R-Ga., offered an amendment to more directly address the troubled municipal bond market. (Caroline Brehman/CQ Roll Call file photo)
Sen. Bob Menendez, D-N.J., center, and Sen. David Perdue, R-Ga., offered an amendment to more directly address the troubled municipal bond market. (Caroline Brehman/CQ Roll Call file photo)
Posted March 30, 2020 at 5:30am

While they face drastic fiscal challenges related to the coronavirus pandemic, local governments hope a provision in the stimulus bill signed into law by President Donald Trump on Friday will help them shore up one oft-used financial tool.

A section in the bill allows the Federal Reserve Board to buy municipal bonds, which advocates for local governments say could restart the market for such bonds. Demand for the tax-exempt instruments — normally considered one of the finance world’s safest investments — that cities and counties depend on to raise money for projects like sewer systems and highways froze up last week as part of the economic fallout from the virus.

Any period of a lack of demand for municipal bonds cripples local governments’ ability to raise money for needed projects. With costs skyrocketing to mitigate the pandemic and revenues falling due to the economic nose dive, access to cheap lending is more important than usual for states and local governments.

State and local leaders have said the $139 billion in direct cash assistance the new law provides to reimburse coronavirus-related costs is just a start. A fix for the bond market might prove more crucial, said Matthew Chase, executive director of the National Association of Counties.

“At the end of the day, this might be the most important provision for state and local, this Federal Reserve piece,” he said.

Advocates for local governments say the provision could restart the market. Demand for bonds has stalled since late last week, sending borrowing rates for local governments from around 1 percent to between 7 and 11 percent, Chase said.

The bill allows the Fed to enter into the municipal bond market as an institutional investor, similar to private sector investment managers, said Emily Brock, chief federal liaison for the Government Finance Officers Association, a group that represents state and local governments.

It’s unclear from the bill language alone exactly how the program will work. The bill gives the Fed and the Treasury Department 10 days to set up a system for the Fed to enter the bond market.

Frozen market

The municipal bond market “essentially froze last week,” Chase said. Investors sold off about $12 billion of municipal bonds. The market saw another $13 billion in outflows Thursday. Bond broker-dealers hold about $10 billion in bonds for which there is little demand, meaning the market can’t move and any city needing to issue bonds for a project isn’t easily able to, Brock said Thursday.

The bill authorizes $454 billion that the Fed could use to purchase bonds, but that includes money to be used for loan assistance to eligible businesses. Although the amount isn’t written in the bill, Brock said she expects the Fed to use $10 billion from its allocation in the bill to help restart the market.

“We wanted the Fed to walk in, purchase some of that inventory that’s just sitting there, relieve the broker-dealers’ books so that other investors could come in as well and start to make buying and selling normal again,” she said.

There are indications the move, and others the Fed has made over the last week, “have helped to loosen up market liquidity,” said Tom Kozlik, the head of municipal strategy and credit for Hilltop Securities Inc.

An aide to Sen. Bob Menendez, a New Jersey Democrat who, with Georgia Republican David Perdue, offered an amendment that addressed the issue more directly, said more will be needed than the provision in the current bill.

“The language included in the bill passed by the Senate this week is not the comprehensive solution necessary to provide support to state and local governments and stabilize the municipal bond market,” the aide wrote in an email. “Sen. Menendez will continue to fight for robust support for state and local governments through the municipal bond market in the next COVID-19 legislative package.”

The original Menendez-Perdue language would have allowed the Fed to buy municipal debt directly, without first setting up an additional system with the Treasury.

House Speaker Nancy Pelosi has also said a fourth COVID-19 response bill should target relief to state and local governments. Governors have said they’ll need more federal funding in the coming weeks and months.