Fed extends municipal lending to smaller cities and counties

The Federal Reserve has expanded the eligibility criteria for a $500bn lending facility set up to backstop municipal bond markets, in a move that will allow smaller US cities and counties to access liquidity from the central bank.

The move by the Fed — on the eve of a two-day meeting of the Federal Open Market Committee, its monetary policymaking body — highlights its growing focus on the financial health of America’s state and local governments, which have suffered deep revenue losses as a result of the coronavirus pandemic.

The Fed’s initial plan to shore up the $4tn municipal bond market, created earlier this month, was criticised for supporting only counties with at least 2m residents and cities with a population of 1m or more, as well as US states and the District of Columbia. Just 16 counties and 10 cities were eligible for the direct purchases under those terms, according to data from Bank of America.

The central bank on Monday said the programme would now be open to US counties with at least 500,000 residents and US cities with at least 250,000 residents, allowing local authorities in places including Baltimore, Maryland, and Westchester in the New York suburbs to access it. 

“The new population thresholds allow substantially more entities to borrow directly . . . than the initial plan announced on April 9,” the Fed said in its statement. Eligible issuers must have an investment grade rating as of April 8 from at least two rating agencies.

The Fed also said it would expand the list of securities eligible for the programme, agreeing to buy short-term notes that mature in 36 months or less. Previously, the Fed had agreed to buy notes maturing in 24 months or less — parameters that had been called “short-sighted” by critics.

Municipal bond prices have stabilised since last month’s selling frenzy, which pushed prices to record lows. Triple-A rated munis maturing in 10 years now yield roughly 1.3 per cent, having spiked to almost 3 per cent in March. Yields for shorter-dated munis maturing in three months have also dropped, indicating a rise in price, and now hover at less than 1 per cent.

On Monday the Fed signalled it was open to expanding the facility even further. It said it might consider allowing a “limited number of governmental entities that issue bonds backed by their own revenue to participate directly”.

In addition, it vowed to “closely monitor” conditions in both the primary and secondary markets to gauge whether additional support would be needed.

The municipal lending facility set up by the Fed was one of several created by the US central bank since early March to bolster stressed corners of the credit markets. The Fed has been open to tweaking the terms of its loan programmes in response to feedback from market participants.

The Fed’s foray into municipal debt markets has also come amid a fierce political battle on Capitol Hill over federal aid to distressed state and local governments.

While Democrats have been pushing for extra funding to help states close budget shortfalls, Republicans on Capitol Hill have been resisting. Mitch McConnell, the Republican Senate majority leader, suggested states should go bankrupt instead.

The financial aid to states and local authorities is expected to be a primary point of contention when Congress and the White House negotiate a new round of fiscal stimulus next month.

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