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The Federal Reserve must renew the MLF or risk hurting towns they tried to help.
The Federal Reserve should reactivate the Municipal Liquidity Facility as the structure and abrupt closing of the program was flawed. A year after the closure of this program, many of the municipalities that the Federal Reserve aimed to help, are now positioned to become victims of this policy.
As part of the 2020 CARES Act, the Federal Reserve created the Municipal Liquidity Facility. The goal of the Municipal Liquidity Facility, or MLF, was to “ help state and local governments better manage cash flow pressures in order to continue to serve households and businesses in their communities.” On December 31st, 2020 the program ceased without a transition plan.
This was a mistake.
Under the MLF, the Federal Reserve began buying short duration municipal notes. Primarily, it purchased tax anticipation notes (TANs), revenue anticipation notes (RANs), and bond anticipation notes (BANs). The goal of this program was simple, provide liquidity stability to municipalities through the purchase of notes. This lowered interest rates for municipalities by increasing demand for their short-term debt. As expected, this caused states and municipalities to borrow more.
The Federal Reserve buying TANs and RANs was a good policy for the tough situation many communities were facing. It functioned like a payday advance, giving communities access to funds they were entitled to but due to the pandemic had not received. Because of the MLF, municipalities paid very little interest on these advances. If the MLF had stopped at purchasing TANs and RANs, the conclusion of the program would have caused little concern.
The concern comes from the Municipal Liquidity Facility ability to purchase BANs.
When municipalities conduct capital improvements, like building a new school, they do so through taking on debt obligations. Commonly, municipalities will use BANs to finance the construction of the project and convert to bonds once the project is complete. Municipalities only pay interest on BANs. Besides the lower payment in the first couple of years, the lack of principal payment means that if the municipality receives any cost participation from the State or comes in under budget it can simply bond less when the BAN expires. This avoids a costly and complicated bond refunding.
By the Federal Reserve lowering BAN rates through the MLF, municipalities were encouraged to borrow more. This incentive was further encouraged by the Fed pushing rates to their lowest historic point during this time period. Municipalities who borrowed through this program did so in a period when the Federal Reserve frequently spoke about maintaining low interest rates for a period of time that far exceeded the duration of a BAN.
The problem is one of timing. A BAN’s duration is typically around one year, meaning BANs sold during the MLF’s existence are now just coming due. Now that the Federal Reserve seeks to expedite interest rate hikes. Many of these communities are left trying to renew their BANs or transition them to long-term bonds in an uncertain interest rate market, primarily spurred by the Federal Reserve changing its position on rates.
This is a problem created by Federal Reserve policy, but it is also a problem that can be solved by Federal Reserve policy.
If the Fed was to re-establish the MLF with the goal of suppressing rates for new municipal bond purchases, this may allay the pressure being put on municipalities. This would give communities the opportunity to transition their BANs to bonds in an interest rate environment much closer to what they expected when the BAN was originally sold. This does not have to be a long program. It only needs to mirror the length of the original MLF, which was less than a year.
Without reviving the Municipal Liquidity Facility, the communities the Federal Reserve was trying to help may become victims of this policy. This would result in higher interest and costs for municipalities. Those higher costs would have to be satisfied by either higher property taxes or cuts to services like education and public safety. The Municipal Liquidity Facility does not need to be a permanent feature of the Federal Reserve, but it should be temporarily reinstated to address this policy shortfall.
Banks Should Continue to Liquify Russian Reserves to Meet Debt Obligations
On March 17th, 2022 the United States Treasury allowed frozen Russian assets to be used to pay a $117 million coupon payment to Citibank, which was processed by JPMorgan. This scenario is likely to playout again as more Russian debt obligations come due in the face of ever-increasing sanctions.
The US Treasury clarified its stance on the legality of US financial institutions receiving debt payments from Russian entities. If the trade was initiated before February 24th of this year, then they may receive the interest and principal payments. Given the authorization from the Treasury to use frozen assets for payment, and the sheer number of frozen Russian assets in the US financial sector, the thawing of Russian assets for western debt payment is likely to become standard practice.
For scale, Russia ended 2021 with nearly $480 billion in external debt, representing 39.5% of the nation’s GDP. According to CNBC and Bloomberg, Russia has $2.6 billion in debt payment due between now and the end of May.
Do not let the defrosting of a White House estimated $80 billion in Russian funds for debt payments be mistaken for economic leniency. The use of these funds to fulfill financial obligations to US banks is a prudent financial and economic policy.
Allowing Russia to default on these obligations does little to enhance the already robust sanctions imposed on the nation. Russia has continued to see its credit rating decline at a record pace. Prior to the pandemic, their S&P rating was BBB-; shortly after the invasion it fell to BB+, and now sits at a CC. None of these downgrades were the product of defaults. Rather, these downgrades are the product of the dismal forecasts for the Russian economy and the consensus that global sanctions and asset restriction have eroded Russia’s future ability to repay debt.
By the Treasury allowing US Banks who lent to the Russian government in good faith prior to the invasion of Ukraine unthaw US-held Russian reserves, they are protecting vital financial systems from undue stress. The payments US banks are collecting are damaging the Russian ledger as they are reducing the nations overall reserves, frozen or otherwise.
Functionally, future tax revenue is the payment mechanism for public debt. Though, future tax revenues are not an asset class. In public basic financial statements, this creates a balance sheet where we see massive liabilities, such as OPEB and Pension obligations with little to no assets to offset them, on a GAAP basis. This forces rating agencies to judge public agencies by a different benchmark than the private sector. For governments, rating agencies focus on the strength of future tax revenues, the economic forecast, and access to cash reserves. Global sanctions have effectively restricted these three criteria.
The natural gas and oil embargo have constrained Russia’s primary source revenue. International trade restrictions have drastically reduced importation and exportation tax streams. Once consistent sources of cash to Moscow have dried up.
The expulsion of Russian banks and businesses from the world’s largest economies have dragged down Russian economic forecasts. The nation’s inability to access global raw material markets will reduce production. Its status as an international pariah only serves to darken its trade prospects.
The removal of the largest Russian banks from SWIFT has shut-off the Russian government from half of its reserves. The freezing of their assets has further removed any potential to access underlying liquidity. This action has cut Russia’s reserves in half.
If US banks were barred from unfreezing Russian assets, the only effect would be a weaker domestic banking system. Current repayments serve little to bolster confidence in future Russian debt offer and certainly won’t stop the continued decline in Russia’s credit rating.
The current sanctions have done their part to completely erode Russia’s ability to borrow, and they should remain firmly in place. By allowing the use of frozen Russian assets to pay debt, the US Treasury is protecting its domestic banking industry while not undermining the severe sanctions put on Russia.