States Need Help From the Fed This Time
(Bloomberg Opinion) -- State and local governments are the main providers of basic public services in the U.S. They are on the front lines of combating the Covid-19 pandemic, the most serious public-health threat in a century. When the number of infected people increases, public hospitals will have to treat them. When schools close or people stay home from work, state and local employees will still have to deliver key public services. But it’s unlikely these governments will have the funds they need to fight the epidemic properly unless Congress acts to require the Federal Reserve to expand state and local fiscal powers.
Compared with the federal government, state and local governments have limited fiscal firepower to fight the pandemic and support local economies. The federal government can readily borrow to fund needed programs. If borrowing fails, the Federal Reserve can monetize new federal spending by printing dollars, the world's reserve currency. In contrast, state and local government must approach the lending market like any private corporation, and their borrowing power is highly constrained. They have very limited ability to surge their spending in response to emergency situations like the one we face now. Just during the past week we have seen major disruptions in municipal funding markets as liquidity collapses and investors scramble to determine the impact of the epidemic.
From 2008 to 2011, the Fed used its monetary powers to bail out Wall Street and the mortgage market. The Fed's balance sheet expanded by trillions of dollars as it bought mortgage-backed securities and flooded Wall Street with dollars to support market liquidity. There was no corresponding Fed effort to assist states and local governments. The Fed’s interpretation of its enabling statute is that it doesn't have broad authority to buy state and local municipal bonds and hold them on its balance sheet, even though it has authority to provide financing for big banks, mortgage borrowing and even for foreign governments. But authority to help state and local governments is limited at best.
Congress could easily address this by mandating the Fed to purchase municipal debt to help state and local efforts to fight the epidemic and related economic fallout. If the Fed provided this low-cost financing, it would instantly give hundreds of different governments across the country the financial ability to put their epidemic-fighting efforts into high gear, funding everything from new medical facilities, protective gear for health-care workers, measures to ensure continuation of key public services and support for social distancing.
Rather than waiting for the federal bureaucracy to take action -- which it has so far been notably slow to do -- or go through weeks or months of waiting for Congress to authorize funding and agencies to approve grant programs, states and localities could immediately spring into action.
Some might object that such a program could be abused. But there are many ways to protect against this. The Justice Department and other government agencies could pursue audits of documentation and records and bring criminal cases for fraud or misappropriation. In addition, coronavirus borrowing could be kept to a limited time horizon, perhaps five or 10 years, so that municipal authorities would know that they would have to pay back the debt in a reasonable period.
In addition to a powerful tool to fight the epidemic, such financing would also act as a strong economic stimulus and protection against a recession. The last recession was significantly prolonged and deepened because state and local governments lacked the resources to maintain or expand employment and services. If state and local governments had managed to maintain employment levels relative to population, more than a million jobs would have been saved.
Of course, Fed financing does not replace the need for direct federal funding in the form of grants or other stimulus, which is critical. But in a fast moving situation such funding could fall short of local needs. During the 2007-2009 recession, which involved many fewer emergency-service demands, states and localities were granted $80 billion in stimulus -- but even that amount proved inadequate to avert job losses.
In the absence of expanded financing powers, states and localities will face impossible choices between funding critical public services and funding emergency coronavirus efforts. The effect will be particularly severe because states and localities rely heavily on sales taxes, which raised more than $400 billion in revenue in 2018. Measures to stop the coronavirus spread, such as closing restaurants and canceling major events, will result in a sharp contraction of that revenue.
It is hard to overstate what is at stake. Evidence from other nations shows that when there are effective social distancing and treatment efforts, contagion falls and fatality rates are less than 1%. In the absence of such efforts, contagion rises exponentially, hospitals are quickly overwhelmed and fatality rates rise to 3% to 5%. Millions of lives are at stake, necessitating a fast and effective response. Using the Fed to financially empower states and localities across the country as first responders is a way to get there.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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