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Unsanitized: The COVID-19 Report for Sept. 25, 2020

The Muni Bond Market Is Preventing Economic Recovery
The role of Wall Street financiers in forcing austerity on state and
local governments

 

Wall Street municipal bond traders do not want to lose fees on $500
billion in lending. (Kostas Lymperopoulos/Cal Sport Media via AP Images)

First Response

**** Federal Reserve chair Jerome Powell and Treasury
Secretary Steven Mnuchin spent the week fielding questions from Congress
about the effect of their bailout rescue and whether it has delivered a
broadly shared recovery. Even those who generally think the Fed has done
a good job have criticized the orientation around the Municipal
Liquidity Facility (MLF), which can offer direct loans to cities and
states suffering through revenue shortfalls. Because of the
counter-productive and unnecessary penalty rate

and generally poor terms, the MLF has only been used twice, leaving
close to $500 billion in borrowing authority unused.

According to the Brookings Institution
,
revenues will decline by between $467 billion and $544 billion between
now and 2022. This compares favorably to the lending authority. And the
Fed has tools to offer short-term, endlessly rolled-over loans

under Section 14, outside the MLF, and give states and cities what they
need to survive, and not completely stunt economic recovery.

"It's driving me crazy, it's almost like a fiduciary duty
violation," said Cornell University's Robert Hockett, who has been
pressuring the Fed to get more creative with its state and local lending
authority. Given that the Fed has a mandate to maximize employment, and
we know that state and local austerity was a lead weight on employment
and economic growth during the Great Recession, it's hard to argue his
point. "It's not even like a long time ago we have to look back,
it's within living memory for us," Hockett said.

So why has the Fed been so reticent to act? Officials managing the
program have expressed that the MLF serves merely as a lender of last
resort, in case of a breakdown in municipal bond markets. Those markets
are the concern, not the condition of state and local governments. And
there's a good reason for that: municipal bond markets are a powerful,
concentrated spoke of the financial industry, and they don't want to
take the loss of revenue that would come with the Fed serving state and
local governments well. So there's a combination of lobbying and
intellectual capture ensuring that nothing messes with their gravy
train. 

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**** The numbers are significant. An analyst at consultant
firm InRecap explains how "federally
subsidized MLF loans would be an alternative to federally subsidized
tax-exempt (municipal) bonds." We have a choice, in other words: amend
the MLF (or use Section 14), and send $500 billion in debt to state and
local governments, or place $500 billion in the muni market through tax
expenditures.

If you extend the MLF loan terms to 30 years-either by fiat or through
committing to roll over the debt-and reduce the interest rate to the
rate on Treasury bonds, the estimated credit losses would be about $6
billion for a $500 billion facility. (see the link
for details.) $35 billion of the MLF
is intended for credit loss absorption, supplied by Congress through the
Treasury. So the minimal losses are already reserved.

The cost of doing nothing, InRecap estimates, is that the MLF goes
unused, and state and local governments tap muni bond markets for the
same loans at the same terms. In that scenario, because of the
tax-exempt nature of the bonds and some other calculations (see the link
), the government will lose tax revenue
of $20 billion in the first ten years, and $35 billion over the full 30.
If the calculation is correct, you're talking about close to six times
as big an expenditure, at the far end, if you just let the Fed handle
the loans. The Congressional Oversight Committee (COC) could ask for a
sharper analysis of this from the Joint Committee on Taxation if they
wanted the numbers.

More important, if the Fed filled the gap, that $500 billion would be
out of the muni markets, meaning those financiers would be denied the
fees that go along with them. And this mentality has carried through to
the government, through former muni traders now placed there.

That includes Kent Hiteshew, who is running the MLF for the Fed. Prior
to his stints at the Fed and at the Treasury Department he had a
"30-year career in public finance on Wall Street
," another way
of saying muni trader. The announcement of the Fed hiring described
Hiteshew as a "veteran muni banker
."
(while at Treasury, he also worked on the junta, the financial oversight
commission, in Puerto Rico.)

Hiteshew, in testimony

before the COC last week, said that the MLF must not "replace private
capital" and that the success of the MLF is based on "the condition
of the municipal securities market." During questioning, Hiteshew
noted that his phone was ringing off the hook for the first time,
alluding to his pals in the muni market. It was a moment where the mask
slipped, and top officials revealed the influence peddling at work to
deny the public sector needed relief.

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"It's a very clubby sector of the financial services industry, they
have a kind of oligopoly status," said Hockett. "That in turn stays
with people who leave to go to work in government."

Hockett shared with me email conversations he had with Marjorie Henning,
a deputy to New York City Comptroller Scott Stringer who has been
delegated to handle options for municipal lending. She expressed deep
skepticism that the Fed could deliver favorable terms. "How can you
say the terms will be generous when the FAQ clearly state that the
interest rate will be a penalty rate, at a premium to the market?" she
wrote. Henning was a Director in the Municipal Securities Division at
Citigroup and spent three decades in the muni market. "It's an
intellectual capture or spiritual capture, they think of the muni market
as a friend," Hockett said. "They're suspicious of anything that
smacks of a public option."

There are several examples of successful federal credit programs in
competition with muni markets that have mysteriously disappeared. Build
America Bonds, the successful stimulus program for supporting state and
local governments, just vanished. The Water Infrastructure Finance and
Innovation Act (WIFIA) loan program, with $13.6 billion in loan volume,
has been a credible replacement for munis
that allows local governments to
increase their water bond financing. It's been defunded in the House
Appropriations Committee for technical accounting reasons. It's hard
to see these all as coincidences.  

If this hypothesis is correct, the muni market, therefore, is helping to
ensure the essentially unusable nature of the MLF, to keep its profits
fat. Progressive members of Congress have been calling for months

to improve the terms of the program, but they can't compete with Kent
Hiteshew and other of Wall Street's friends in high places.

One of the reasons to question whether the stock market reflects the
real economy

is that the majority of the workforce doesn't work for listed
companies. (Nathan Tankus's linked piece has some interesting elements
but my point stands.) That includes the 13 percent of the workforce at
state and local governments. The Fed has the power to broaden its
functionality
to the
local level so more people are affected by its actions. It chooses not
to, and the links to the muni market have to be seen as part of that.

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Today I Learned

* It was fun to be in the Center for Public Integrity's long-form
podcast about Steven Mnuchin. Here's a transcript of my episode
.
(Center for Public Integrity)

* Democrats prepare new coronavirus relief proposal

that won't go anywhere. (Wall Street Journal)

* The state of Iowa fined a beef plant the equivalent of 64 10 oz.
ribeye steaks

for sickening its workforce with coronavirus. (Associated Press)

* Great feature on micro-economist Raj Chetty's work

on targeting economic stress. (Bloomberg Businessweek)

* Amazon workers selling products at Whole Foods stores are ignoring
social distancing rules

and causing chaos. (Business Insider)

* Despite the CDC moratorium, eviction filings by private equity
landlords

are way up. (PE Stakeholder)

* Pac-12 football is back
,
meaning all the Power 5 conferences will play. Sadly it's safer than
being a student in college. (San Jose Mercury News)

* Psychological yearning for simpler times: Halloween candy purchases
have spiked
.
(The Hill)

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