A major push for direct aid to state and local governments and coronavirus vaccine distribution make the Federal Reserve unlikely to create new municipal market backstop programs in the foreseeable future.
Most muni market participants say there is no sign of a second wave of market dislocation as seen in March 2020, when the Fed stepped in to create the Municipal Liquidity Facility among other programs aimed at stabilizing the financial markets.
“It seems like the vaccines are doing their job,” said Brian Egan, policy director of the National Association of State Treasurers. “It seems like additional stimulus and fiscal policy are on the horizon. I don’t particularly see any impending market dislocation at this point in time.”
In 2020, the Fed stood up two programs to help the municipal market — the MLF and the Money Market Mutual Fund Liquidity Facility — to stem the rising fund outflows and other signs of distress observed in the early days of the pandemic's spread to the U.S.
The MLF was open to counties with populations of 500,000 or more and cities of 250,000 or more, and charged issuers a premium to purchase short-term debt with a maturity no longer than 36-months.
Since then the municipal market has been strong, with municipal issuance reaching very high levels. If the market continues to strengthen, the Fed won’t intervene, but just continue to monitor the markets, Egan said.
From a state and local perspective, many were holding out for Congress to provide direct aid and preferred that over the Fed’s lending programs.
“We’ve long said the Fed did its homework last year in providing monetary stimulus and much needed monetary policy, but from the state and local perspective, we were holding out for Congress to provide fiscal aid,” Egan said. “It seems like we’re probably within a month of possibly seeing that materialize finally.”
“I don’t see a market dislocation coming with the positive news of the vaccine and the positive news of potential additional stimulus,” Egan added.
Market dislocation is still possible, but it’s less likely that it would be as violent as in March 2020, said Matt Fabian, a partner at Municipal Market Analytics.
“There is less uncertainty now about what the pandemic means to credit,” Fabian said. “People are still concerned, but the violence in March reflected the lack of knowledge among participants about what exactly all of this meant for municipal credit.”
The Fed would need a clear direction from Congress to create new municipal programs, Fabian said.
“It seems unlikely that the Fed would roll out a new program without a specific congressional mandate to do that,” Fabian said. The MLF received criticism from both sides of the aisle, with some Democrats saying eligibility needed to be expanded and some Republicans saying the MLF wasn’t needed given market conditions.
“It makes it less likely that the Fed would be the first actor in creating a new program,” Fabian said.
The MLF expired on Dec. 31, 2020. A $900 billion relief bill was passed that month with a clause saying that the U.S. Treasury can't fund a program "the same as" the MLF. Specifically, the bill prevents Treasury from investing money from the Exchange Stabilization Fund that are the same as the MLF and prevents the Fed from putting money it gets back from its MLF loans to go towards new loans. That money would need to be returned to Treasury.
But the Fed can act on its own, without Treasury funding, with approval from Secretary Treasury Yellen. The Fed could still create a program to help the municipal market that is similar to the MLF.
Also, Section 13(3) of the Federal Reserve Act still holds despite changes in the December law. During the Great Depression, Congress gave the Fed emergency lending authority for “unusual and exigent circumstances.” After the financial crisis in 2008, Congress put in restrictions on that section of the Federal Reserve Act such as requiring the Treasury Secretary to sign off on its lending authorities.
The Fed had the authority under the CARES Act in March to lend up to $500 billion for state and local issuers through the MLF. The U.S. Treasury provided $35 billion from the Exchange Stabilization Fund, using funds appropriated under the CARES Act. The rest of the funding came from the Fed.
Only two issuers used the MLF — Illinois and the New York Metropolitan Transportation Authority.
Importantly, the Fed creates lending programs expecting the loans will be paid back with interest.
The Fed has rolled out programs in the past on its own such as the Commercial Paper Funding Facility in 2008 to provide a liquidity backstop to U.S. issuers of commercial paper. However, the Fed had never acted on municipal programs until this past year.
During a December press conference, Chair Jerome Powell said the Fed had the ability to do facilities under 13(3) in some cases with no backing.
“We would have the ability—certainly, we would have the ability to do facilities under 13(3) in some cases with no backing,” Powell said. “But we can’t do any 13(3) facilities without the approval of the Treasury Secretary, right?”
Powell added that the Fed would use its authorities if needed and if the law allows.
“We’ve been very focused on, on the issues that are right in front of us,” Powell said. “And, honestly, we’re not—we’re not planning on anything or having any discussions about what we might do down the road.”
During a late January press conference, Powell said he had not had any discussions with the Treasury on its lending facilities.
