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Securities Law

Fed Pushed to Loosen Reins on Nearly Untapped Muni Program (1)

July 14, 2020, 3:34 PM

The Federal Reserve is facing pressure to loosen the rules on its $500 billion municipal lending facility, which charges penalties so steep that almost no governments are willing to borrow from it.

A group of state treasurers, local officials and advocacy groups including Americans for Financial Reform, a Washington-based advocacy group, sent the central bank a letter on Tuesday requesting that it significantly cut the interest rates it charges on loans. The groups also asked it to lend for longer terms and expand the number of governments that are eligible to borrow.

The Fed announced the Municipal Liquidity Facility in April to ease the cash crunches facing U.S. states and cities by buying short-term debt sold to cover revenue shortfalls caused by the pandemic.

The Fed’s move, its first-ever intervention into the municipal market, caused bond prices to rebound by ensuring that states and cities could continue to raise needed funds. But the central bank is charging such high penalties that it has had virtually no impact aside from improving investors’ confidence, with near junk-rated Illinois the only government that’s facing steep enough yields on Wall Street to make borrowing from the Fed worthwhile.

The modest scope stands in contrast to the Fed’s broader intervention into the corporate debt market, where it has has been buying securities in the open market.

“What they’ve done is set up a program that gives munis a bad deal compared to the muni market and a bad deal compared to the private sector,” said Marcus Stanley, policy director at Americans for Financial Reform.

The Fed has shown willingness to modify its lending program, though at the moment states and cities can easily borrow in the public bond market, where yields on one-year debt have fallen to about 0.18%, less than they were before the March selloff. It previously cut the population thresholds so that more local governments are eligible and is allowing some agencies like New York’s subway system to access it.

Kent Hiteshew, who the Fed hired to help oversee the municipal program, said at a Brookings Institution conference on Monday that the central bank remains “vigilant” about whether more intervention is needed. He said the program is designed as a backstop and officials have been mindful that loans are no substitute for the direct aid that state and city officials are pushing for from Washington.

Americans for Financial Reform and the other letter signatories asked the Fed to buy debt with a longer maturity than three years and that the program be extended beyond the end of this year.

The Fed’s corporate credit facilities have made $10.7 billion in purchases, while the central bank had made just one municipal loan -- to Illinois -- totaling $1.2 billion, according to data released July 9.

Stanley said that the Fed can set terms that would induce state and local governments to borrow, helping the U.S. recover from the recession caused by the pandemic.

“Why would you make this amount of money available if you don’t want munis to use it at all?” he said. “They made it available but set rules such that people are not likely to use it and are not using it.”

(Adds short-term yields.)

--With assistance from Craig Torres.

To contact the reporter on this story:
Amanda Albright in New York at aalbright4@bloomberg.net

To contact the editors responsible for this story:
Elizabeth Campbell at ecampbell14@bloomberg.net

William Selway, Christopher Maloney

© 2020 Bloomberg L.P. All rights reserved. Used with permission.

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