Federal Reserve Must Boost Support for State and Municipal Finances

By Faith Taylor

Throughout the pandemic, the federal government’s actions have worked well for the investor class but less so for everyday Americans. The Federal Reserve has ensured that corporate bond markets boom even as unemployment and hunger spread, and Congress is deadlocked over a new relief bill. One casualty: state and municipal governments.

The Fed’s current effort isn’t effectively providing aid to local governments. Its Municipal Liquidity Facility has allocated $500 billion to cities, counties, and states but has been almost unused since its announcement. States are hesitant to participate for many reasons, one being the high interest rates and short terms associated with the loans. The interest rate for an MLF was at first nearly triple the rate (now slightly lower) than a loan in the traditional municipal bond market.

Another reason the program has a lack of participation is that the program has too-strict population requirements. Under the original guidelines, only 10 cities and 15 counties were large enough to qualify. But even after the Fed tried to make the program more friendly to small governments, Illinois has been the only state borrower. It’s obvious that states don’t believe the program is in their best interest. The Fed needs to do better, and a large group of state treasurers, local officials, labor unions, and public interest groups have told them so.

Part of why the economy took so long to recover from the Great Recession that followed the 2008 financial crisis was that states had to make large cuts in their budgets. To help state and municipal governments, the Fed needs to actively buy new issues of state and municipal bonds at very favorable rates and hold them. Then, governments can focus on funding necessary projects and keeping people on the payroll. With a painfully high unemployment rate, the Fed should be doing everything it can to keep incomes stable.

Most states have requirements to balance their budgets, and with a large debt and inability to borrow freely, states will be forced to cut jobs. We have already lost more than 1.5 million state and local jobs and 2.8 million more are in danger. This will disproportionately affect communities of color, who make up a large number of government employees. By helping states and municipalities make ends meet, the Fed will make a small contribution to bridging the racial wealth gap.

It’s imperative that state and local governments get support from the federal government and don’t face pressure to cut their budgets. One part of the solution is direct payments from Washington, but the Fed can help with the sheer uncertainty created by the COVID-19 crisis. Fed loans to states and municipalities are part of the solution to that uncertainty, which will depress American economic growth for years to come.