The HEROES Act should be viewed as a floor, not a ceiling
State and local governments, public employees and taxpayers in a large number of states are badly in need of financial support from the federal government.
As budgets get damaged by sharp cuts in tax revenues and increases in costs, governments need to deal with major issues related to the COVID-19 pandemic and to erosion in the economy as a result of the virus. Just on Tuesday, chief economist Josh Bivens at the Economic Policy Institute indicated in a new report that suggests “a prolonged depression is guaranteed without significant federal aid to state and local governments.”
While such work must often be considered in a context of advocacy, that does not appear to be the case here. Bivens’ basic themes would appear to be broadly correct.
Predictions for economic growth over the next several quarters, at the very least, are sharply negative. The policy case for federal support is strong: in the pandemic, we are looking at an emergency that is the equivalent of 50 states worth of hurricanes fires and floods, lasting more than two years, with a very slow economic rebound on the “other side,” that leaves states, local governments, public employees and taxpayers all badly damaged.
From a broad market perspective, the stock market is clearly “betting” on the small but real chance that the positive early vaccine test results will lead to an earlier global distribution of vaccinations than the baseline had been. (Still probably more than a year away, best case, including deeper tests and then production.) That is what stock markets do, but it is not at all clear that it is what a COVID vaccine in tests would do.
Municipal investors—and rating agencies—ought not be leaning on the same high-risk outcome. That is not what investment-grade municipals are supposed to be all about. Or state and local governments. Many, many vaccines that look good in early tests fail badly—see HIV, Ebola, SARS. And if people start assuming an impending vaccine, the likely second phase of the pandemic could become magnified by more careless behavior.
It would be especially unfortunate if the signal coming from the stock market gave members of Congress an excuse not to provide state and local governments with the fiscal policy support they so badly need. That would be a political outcome, not a policy outcome.
The good news, for now, is that the House’s HEROES Act provides $3 trillion in further expenditures for a variety of targets and activities. The allocated State and Local Government Coronavirus Relief Funds make up $916 billion of the anticipated proceeds, with $500 billion allocated to the states, and $375 billion allocated to local governments, along with other, smaller expenditures. Funds are to be available until expended, providing flexibility over the next several years.
The bad news is straightforward: the Senate is highly resistant to further federal expenditures of this magnitude to fight the pandemic, given that the federal government is already on its way this year to spending nearly $4 trillion more than it collects in revenue.
This would be a budget deficit roughly twice as large relative to the economy as in any year since 1945. Of course, roughly half of that related to existing promises and cuts in taxes, having nothing to do with the pandemic.
Nevertheless, in our view, state and local governments—and the federal economy—are facing a major crisis at a time of substantial resistance from the Senate, particularly from deficit hawks that are rearing their heads for the first time in years.
The other bad news is the House-allotted $916 billion likely will not be anywhere near sufficient, given the magnitude of the economic crisis. The state of California alone is forecasting a $54.3 billion budgetary deficit for fiscal 2021, and that does not include shortfalls at the local level—municipalities, counties, school districts and special purpose activities, from colleges through facilities servicing the elderly, nor does it include ongoing shortfalls that will extend beyond 2021.
If the Senate cuts back from the proposed House levels, we anticipate a wide number of major concerns, ranging from very sharp cuts in services, to widespread cuts in public payrolls, to reduced capacity to respond to the pandemic as a form of economic stimulus, to—importantly—severe cuts in credit ratings that the rating agencies will be forced to consider, for states, for local governments, and for revenue bond issuers and special purpose financings. At a wide number of levels, both consumer behavior will remain muted in ways that will leave huge holes in governmental budgets, and that will be extremely slow to reverse. And, we note, states and most local governments, are required to maintain balanced budgets, so that lack of a sufficient Federal response will rapidly be turned into aggressive budget, payroll and service cuts—and then sharp cuts in inherent credit strength.
The implications of such erosion in credit strength will be jarring, but we do not envision that it will even begin to be fully felt by the market—either in ratings, or in market valuations—until the market can better discount the anticipated outcome of Senate-House negotiations over the Federal/State component of the Heroes Act.
The governors on the frontlines know this. In a joint statement, Maryland Gov. Larry Hogan (R) and New York Gov. Andrew Cuomo (D) said states need at least $500 billion in aid to make up for revenues lost during the crisis.
They note that the lack of federal moneys is leading to deep cuts in spending and payrolls that will severely limit any rebound out of the pandemic-induced economic crisis.
"Each day that Congress fails to act, states are being forced to make cuts that will devastate the essential services the American people rely on and destroy the economic recovery before it even gets off the ground," Hogan and Cuomo wrote.
They note the wide bipartisan agreement on strong federal support for state, local and tribal activities. Despite this support, Senate Majority Leader Mitch McConnell appears to remain dismissive, calling such support “exactly the wrong approach.”
To that, we respond, what then is the right approach?
Gutting state and local payrolls and risking a deep dive in access to capital as credit damage spreads seem to us to be an simply awful approach, contrary to governmental policy or economic requirements.
Additionally, in the absence of deep, readily available federal money, other urgent matters, such as infrastructure, generally responding to climate change, and reconfiguring cities and towns for the post-pandemic American economy would be tossed to the wayside.
Where do we go from here?
The case for the federal government to take on provision of support for state and local governments, is a strong one. A key factor is the ongoing extremely low borrowing costs at the federal government level, with 10-year Treasuries at around 0.70%, versus if the federal government doesn’t take on that role, the damage to the entire U.S. economy will be vastly greater than necessary.
The calculation of the damage from the pandemic specifically for any given state, local government or special purpose facility is relatively straightforward: on the revenue side, losses in income taxes, sales taxes, property taxes, and revenues that previously were providing income or avoiding deficits, including hospitals, mass transit, ports and airports, and a host of other special purpose governmental projects, including higher education, transportation and utilities.
On the expenditure side, increased deficits include increases in unemployment insurance and healthcare costs, but also a number of major sources of spending that we do not find fully explained or calculated in most discussions.
These include provision of food and healthcare to uninsured users of healthcare facilities, support for housing to prevent foreclosures and evictions (where the need is likely to be vast), and quite simply, a need for state and local governments (but especially states) to step in to prevent personal fiscal insolvency among the vast hordes of unemployed and underemployed families and individuals.
Unfortunately, at this point in time, it seems unlikely the Senate, in particular, will provide anything close to the money needed to fill these budgetary holes.
Federal payment for a large portion of these costs would not be providing a “Blue State Bailout,” as McConnell and others have suggested.
The moneys we are discussing are very specifically related to revenue losses and expenditure increases resulting only from the pandemic; any talk of such a bailout, identified fairly, relates to other budgetary issues that existed prior to the time when COVID-19 showed up.
In my view, neither the rating agencies nor municipal market pricing are doing a sufficient job of signaling just how essential the federal role in filling state and local budget gaps related to COVID-19 is likely to be, and how dire the impact for credits is likely to be if the federal government doesn’t take on that role. In a sense, a vast number of credit ratings are currently “provisional”: they can only withstand broad-based further erosion if commitments to state and local government in something equivalent to the Heroes Act actually get enacted.
Frankly, it is the nature of rating agencies to await a tangible change in identifiable risks before changing ratings, rather than including such a change as a measure of new, future risks. Unfortunately, under the current, unique circumstances, state and local governments require that ratings function as a “signaling mechanism” for badly needed federal intervention. Lack of such a signal essential reduces the pressure on Congress to act as it currently needs to do.
For now, suffice it to say that in our view, these risks to provision of essential services, to keeping our economy functioning, to maintain payrolls, and by extrapolation to a wide range of state and local credit ratings, appears to be under discounted in current ratings and market valuations.
There is a crisis unfolding unlike what we have ever seen before and truly the only way to fix it is with direct federal aid to the very core of the American economy — state and local governments. We note that in several recent speeches, Fed Chairman Jerome Powell suggested strongly the importance of a fiscal component to federal support for state and local governments—that the liquidity provisions included in prior legislation and implemented by the Fed itself will not be sufficient. Who are we to argue with the Fed Chairman?