Federal Reserve Chairman Jerome Powell hasn’t wavered in his warnings to lawmakers since the coronavirus crisis hit: Congress needs to bail out state and municipal governments to avoid an anemic economic revival.
“It will hold back the economic recovery if [states and localities] continue to lay people off, and if they can continue to cut essential services,” Powell testified to the House Financial Services Committee last week. “And in fact, that's kind of what happened post the global financial crisis.”
But Powell has shown little interest in using a long-standing central bank power to step in if Congress fails to heed his warnings. Instead, the central bank has opted to rely on a tool provided by a March law. That tool, the Municipal Liquidity Facility, announced in April to help state and local governments manage their cash flow, has been designed to avoid central bank losses — and has been used by only one government to date.
“Would the Fed consider making changes to the municipal liquidity facility that make it more like a grant and provide that would be able then to provide more assistance to local governments?” Sen. Catherine Cortez Masto, D-Nev., asked Powell at a Senate Banking Committee hearing last week.
“No. We can’t make grants,” the Fed chairman replied. “That’s one thing we can’t do. We can only lend — the law is extremely clear on that.”
The line between a loan and a grant isn’t as black and white as Powell suggests. Extend a repayment date far enough and charge a low enough interest rate — or none at all — and a loan can do as much as a gift to help balance a budget.
Fed watchers say Powell's caution is a sign of the fine line he is walking between shoring up the economy and maintaining the support of congressional Republicans opposed to a bailout for state and local governments.
If Powell did directly what he has intimated that Congress should do — bail out the states — senators like Florida Republican Rick Scott would come for his head, said Sarah Binder, a professor at George Washington University who wrote a book on the Fed’s relationship with Congress. Scott has declared his opposition to state bailouts.
“They [the Fed] don't seem to want to be in the position of choosing winners and losers given that the winners and losers have excellent representation in Congress, who are the Fed’s bosses,” Binder said.
The Fed's authorizing law includes Section 14(2) that effectively allows it to turn loans into grants. It can buy state and local debt directly. That provision limits the Fed to notes with six-month maturities, but it could roll that debt over repeatedly to lengthen the term. The Fed has never used its 14(2) powers to buy municipal debt, and Powell has shown no interest in starting now.
The central bank has opted to rely on $35 billion from the Treasury to set up the $500 billion Municipal Liquidity Facility for buying short-term notes issued by state and local governments. That mechanism is considered a Section 13(3) emergency facility, which is meant to avoid losses. The Fed added another safeguard to the facility that is irking critics, but could reassure lawmakers who oppose bailouts: it set fixed interest rates that may be higher than states and localities can find in the private market.
So far, only Illinois has used the program, issuing a one-year, $1.2 billion bond with a 3.83 percent interest rate to fill this year’s budget gap after COVID-19 cut revenue estimates by $2.7 billion.
It’s no coincidence that Illinois — a state with the second highest debt-to-GDP ratio in the nation and the largest unfunded pension liability, according to the Truth in Accounting think tank that monitors government debts — was the first, and so far only, issuer to use the Fed’s facility, said Benjamin Dulchin, director of the Center for Popular Democracy’s FedUp campaign.
“The rules that they’ve set up for it entirely undermine it in a way which is sort of shocking,” Dulchin said. “We want [states and municipalities] borrowing, right? We want them keeping programs going, we want them keeping people from being laid off. And the Fed, in setting high prices for the facility, is not accomplishing that.”
According to a FedUp analysis, out of the 255 states, cities and counties that meet the Municipal Liquidity Facility’s population size and credit rating requirements, “97 percent are functionally excluded because their credit rating makes it much cheaper for them to go and borrow the money on the private market.”
Dulchin says Powell should loosen the facility’s terms by dropping the interest rates below market prices and lengthening the maturity dates. “He could be, and should be, setting the terms of the Municipal Liquidity Facility so it is actively incentivizing local governments to borrow and keep investing in their citizens to help us get through crisis,” he said.
States face a massive shortfall in tax revenue from the coronavirus’ cratering of economic activity. Estimates vary on the exact budget damage, but most agree it will be massive. The right-leaning American Enterprise Institute forecast a $148 billion shortfall over this fiscal year and the next, while the liberal Center on Budget and Policy Priorities put the fallout at $615 billion over fiscal years 2020 to 2022.
Unlike the federal government, most states and localities are legally barred from deficit spending and must balance their budgets annually.
So far, more than 1.5 million state and municipal jobs have been cut in the pandemic — double the size of the culling in the Great Recession. A survey by the National League of Cities found that more than 700 have postponed or canceled plans to repair roads, buy new equipment or make other infrastructure upgrades. The National Association of Counties counts 120 that have already furloughed or laid off employees. Teachers have been especially hard hit — Boston told 2,000 that they won’t be returning to the classroom in the fall, absent an influx of federal funds.
More pink slips could be coming. States and localities face a looming deadline: The fiscal year ends June 30 for every state except New York, Michigan, Alabama and Texas, and for hundreds of counties and cities.
While the roughly $2 trillion pandemic relief package (PL 116-136) passed in March included $150 billion for states and localities, that money was restricted to coronavirus-related expenses. And, according to the National League of Cities, 69 percent of cities have yet to see any of those funds.
Democrats would provide $1 trillion to states and localities in the bill the House passed in May (HR 6800). But Senate Republicans say they won't take that bill up, and are split on the idea of helping out states. Many, like Senate Majority Leader Mitch McConnell, have emphasized that, if Congress does provide more money, it should be capped at actual revenue shortfalls rather than used to address preexisting financial headaches like underfunded pensions.
Scott has been categorically opposed to granting any more money to states. “There’s no way we’re going to do that,” he said Wednesday. “Are we going to bail out New York? No way.”
While Scott was governor, Florida’s unfunded pension liability rose from $18 billion in 2011 to $30.3 billion in 2019.
Powell was warned in his House appearance last week to steer clear of fiscal policy, the responsibility of Congress.
“As the Fed embarks on protecting the economy through careful and targeted use of its powers, Congress must be realistic about what the Fed can and cannot do,” House Financial Services ranking member Patrick T. McHenry, R-N.C., said. “The Fed is a lender. The Fed is a lender of last resort. It is not responsible for fiscal policy. That's Congress's action.”
To respond to the COVID-19 pandemic, the Fed took some unprecedented steps, like buying corporate bonds. Those actions created winners among large debt-issuing corporations while doing little for smaller companies and workers, as the bipartisan Congressional Oversight Committee noted in its report last week.
"Those bonds don't have representation in Congress,” Binder said. States do. So, indirectly picking winners and losers through broad measures to support financial markets doesn’t come with the same political risks as lending to states, she said.
"It’s a long-term issue for the Fed that they seem quite hesitant to get involved in taking actions that affect actual geographic entities, as opposed to other elements of the financial sector,” Binder said.
Binder noted that the only changes the Fed has made to the Municipal Liquidity Facility, so far, has been to loosen the population limits for cities and counties. It did that in response to calls from lawmakers like Senate Banking Chairman Michael D. Crapo, R-Idaho, who complained small towns in his state were getting shut out while big cities could participate — even though none actually have.
“The Fed doesn’t want that type of criticism,” Binder said. “Their credibility depends on having political support in the Congress for what they're doing.”