Any future Federal Reserve programs aimed at backstopping the municipal market need significant changes from the now-defunct Municipal Liquidity Facility, according to several lawmakers and witnesses who participated in two hearings on the subject.
Two hearings before the House Financial Services Committee in the last week outlined some of those changes.
“Some of my colleagues don't understand even how some of the products like bonds, or margin calls work as they've criticized programs where there is literally no buy side in the market,” Rep. Warren Davidson, R-Ohio, said during a Thursday hearing. “And of course, the Federal Reserve stepped in to create a buy side and support the markets.”
“I've heard colleagues say, ‘Well, there are only two loans under the municipal liquidity facility, for example, while there were hundreds of loans, hundreds of billions of dollars of credit extended,’” Davidson added.
A second hearing a week ago looked at some of those problems and Claudia Sahm, senior fellow at the Jain Family Institute and a former Federal Reserve official outlined some of the changes she believes could improve the lending facilities.
“We should tailor the eligibility and the loan terms so that they are specifically for state and local governments experiencing financial distress,” Sahm said. “To do so, use economic conditions, particularly conditions in the local labor markets to make those determinations.”
Federal Reserve Chairman Jerome Powell has been for months crediting the program as an important backstop for markets, and doubled down on his position Thursday. But still, there are many that are unhappy with the way those lines of credit have been dispersed.
“If we do better targeting, then it'll be the state and local governments that most need the aid, and we can potentially reduce penalty rates,” Sahm added. “We can subsidize those rates because you aren't opening up to all institutions, you can be very targeted and tailored in the relief.”
As Davidson mentioned Thursday, the two loans that made up the MLF were just a fraction of what others received.
“The state and local governments only had access to two bonds up to three years of maturity. They were worth more than that for corporations,” Sahm said.
While some excuse the Fed for rolling out such a program for the first time in its history and quickly stabilizing muni markets, others complained it didn’t reach the targeted recipients fast enough.
“Finally, [the Fed should] improve the administrative systems so that it is as easy as possible for those who need the relief to access it,” Sahm added. “We know that swift and effective relief is absolutely essential in times of crisis.”
But arguments that the Fed shouldn’t involve itself in credit policy to begin with still persist, and in doing so, could have a different role in the next crisis.
“The purpose of the lender of last resort is liquidity, not credit,” Christopher Russo, post-graduate research fellow at Mercatus Center said in the subcommittee hearing last week. “Using the Fed for credit policy damages its independence, making it less effective in the next crisis.”
