The lame-duck Treasury secretary seems to want to sabotage Biden’s ability to stave off the pandemic’s economic impacts.
Published in The New Republic.
Right now, cities and states across the country are being forced into crippling budget cuts. As tax revenues fall in the pandemic-induced recession, officials are shrinking public payrolls and slashing services. Even the traditionally Republican American Enterprise Institute has come to warn about the risks to the economy from these cuts, projecting a $105 billion shortfall in state revenues in the current fiscal year—and a gap more than twice as large in the coming year.
These shortfalls bring real pain. In just one example, even as 500,000 people were counted as unemployed in New York City in September, Mayor Bill de Blasio, facing a $5 billion budget deficit, announced he would have to lay off another 22,000 municipal workers. Such cuts will make the economic crisis more acute, heightening unemployment and further eroding the tax base. Nationally, Moody’s estimates state budgets will lose $434 billion in revenues by 2022. As the company’s chief economist told The New York Times about the current wave of austerity facing cities and states, “We run the risk of descending into a dark vicious cycle.”
There’s no reason to steer the nation in this direction. As part of the Cares Act passed in late March, Congress appropriated $454 billion to backstop emergency lending managed by the Federal Reserve. Leveraged at a ratio of 10-to-1, this deposit was designed to fund some $4 trillion in emergency credit. The fund was initially seen as a slush fund to support big business, and congressional Democrats criticized a variety of disbursements for benefiting corporations that laid off workers during the pandemic. However, there’s nothing in the Cares legislation that limits it to corporate America. In fact, the statute indicates that the funds can be used to support not only “eligible businesses” but also states and municipalities.
In an interesting twist, the great majority of the money has gone unused—meaning that there exists a huge pool of money that could be used for stimulus, without requiring further authorization from Congress. But an important first step in expanding the Fed’s support for cities and states will be heading off Republican moves to try to shut down lending before the Biden administration ever takes office.
In the past week, the political battle over this pool of money has intensified. Lame-duck Treasury Secretary Steven Mnuchin has joined with Republican senators to try to phase out the lending facilities established to help cities and states, demanding that the resources earmarked for the Fed be returned to Congress—where, conveniently enough, the Republican’s Senate majority will allow them to control any stimulus that is given.
Federal Reserve Chairman Jerome Powell has good reason to resist these maneuvers and to use the Fed’s powers to provide much more generous lending assistance to cities and states than has been distributed thus far. Once the Biden administration takes over, the Fed could work with a new Treasury secretary to turn available resources into a robust fund to help cities and states maintain critical services, keep public servants working, and promote government activity to keep the economy afloat until the pandemic is defeated.
In April, the Fed, with cooperation from the Treasury Department, set up a facility expressly designed for public sector support. Called the Municipal Liquidity Facility, or MLF, it was funded with a promised investment of $35 billion and authorized to facilitate lending up to $500 billion. But like the rest of the tools in the Fed’s $450 billion “money cannon,” it has been very lightly used. While the existence of the facility helped to revive municipal bond markets, the Fed’s punitive interest rates made the MLF a very weak “public option.” Only two public entities—the State of Illinois and the New York Metropolitan Transportation Authority—have even bothered to try borrowing from it so far.
While the Federal Reserve initially announced that it would not purchase municipal bonds after September 30, 2020, the Fed and the Treasury agreed in the summer to extend the MLF through the end of the year. Since then, Republicans have pushed to close the facility, expressing a clear desire to prevent the Biden administration’s Treasury Department from being involved in directing its use. Addressing the prospect of further extending the MLF, Pennsylvania Senator Pat Toomey, who sits on the Congressional Oversight Committee charged with monitoring Federal Reserve implementation of the Cares Act, told The Wall Street Journal, “I feel really strongly that’s a bad road to go down.… These programs under different management could be very, very badly misused.”
On November 19, Mnuchin formally backed Toomey’s position, requesting that “the Federal Reserve return the unused funds to the Treasury.” In a subsequent interview, he suggested that the money would be sent back to Congress and that lawmakers could use it as funding for a new round of stimulus. In principle, his argument is not a bad one: A new round of stimulus from Congress is long overdue, and giving grants to the states would be a simpler and more generous route than financing debt. But there is no reason additional congressional spending should come at the expense of Federal Reserve lending to states and cities. In practice, Mnuchin’s position is a cynical one. His actions are an attempt to limit a Biden administration from being able to use Fed-Treasury cooperation to address the crisis in the states without having to rely on action by an obstructionist Republican Senate.
With the pandemic spiking and the economic conditions of the states worsening, the view that the MLF has done its job appears sadly misguided. Senate Minority Leader Chuck Schumer has called the deadline for expiration “dangerously premature.” Oregon Senator Ron Wyden described Mnuchin’s November 19 letter to Powell as “economic sabotage.” According to the senior Democrat in the Senate Finance Committee, the Treasury secretary “is salting the earth in an attempt to inflict political pain on president-elect Biden.”
Powell has signaled that the Fed might agree. “When the time comes, we’ll put those tools away,” he stated about the emergency lending powers on November 17. “I don’t think that time is yet.” Responding to Mnuchin’s November 19 letter requesting the Federal Reserve close down the MLF, the Federal Reserve released a statement indicating that it would “prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy.”
The question of who has final control over the MLF’s future is ambiguous. So far, the Treasury and Fed have acted in concert with decisions about the Cares-related facilities, seeing it as in their mutual interest to work collaboratively. The Board of Governors likes to see itself as apolitical and above the fray, acting on technocratic judgments about what best allows markets to function, rather than explicit decisions about economic policy that reveal its role in creating winners and losers. Moreover, they fear that moves that could be labeled “activist” might prompt Congress to challenge the seven-decade tradition of “central bank independence” in the United States that dates to the Korean War.
Such concerns have no doubt limited Powell’s willingness to ramp up conflict with Mnuchin, although disagreements have now broken into the open. The Fed insisting on the continued need for lending to fend off state and local austerity increases the likelihood that the facilities might be able continue in their current form—or, if closed, that they could be revived anew under a Democratic White House with willing cooperation from the central bank. “If the Trump administration decides not to extend the programs,” The Wall Street Journal has reported, “Mr. Biden’s Treasury Department could determine whether to reactivate them in some fashion after the new administration takes office Jan. 20.”
Such reactivation might involve a legal battle that pits the different parties’ interpretations of the Cares legislation against one another. While those who oppose federal financing of state and local governments argue that deadlines in Cares prohibit further action in the new year, a variety of experts contend that the law will give incoming officials room to maneuver, regardless of the views held by congressional Republicans and Mnuchin. “They don’t have the power to shut it down,” says Bob Hockett, former counsel for the New York Federal Reserve and the International Monetary Fund, and now a professor of law at Cornell. “They would have to legislate a shutdown.”
Of course, keeping the facility going in order to stave off the possibility of worsening downturn in the future is just the bare minimum. To address the austerity crisis that is already taking shape, the Fed could express an intention to create much more favorable conditions for lending to cities and states.
One reason so few public entities have turned to the MLF is that Kent Hiteshew, the longtime municipal bond dealer whom Powell hired to manage the facility, has made it clear he is not willing to step in to replace private lenders—the same people who were his colleagues for decades. “Our mandate is to serve as a backstop lender,” Hiteshew told Congress in September, “not as a first stop that replaces private capital.” Under his leadership, interest rates offered through the MLF have included penalty rates too severe to prompt local officials to start thinking creatively about how to use federal assistance to avert budget cuts. “The pricing is pretty punitive,” says Skanda Amarnath, director of research at Employ America. “It keeps out a lot of issuers who might otherwise be able to access the MLF if the rates were more affordable.”
“Having Hiteshew in charge of the MLF is a little bit like having Betsy DeVos in charge of the Department of Education,” Hockett argues. “It’s in the hands of a guy who fundamentally doesn’t believe in the program to begin with.”
By demanding penalty rates of those supported by the MLF, the Fed is treating local governments in a manner similar to the banks being bailed out after causing the 2008 financial crisis. Of course, our cities and states were not responsible for creating the pandemic, making the idea that favorable lending to them would cause a moral hazard a fundamentally misplaced notion.
But even if the Fed makes better lending available, states and cities must be convinced to use it. Those who oppose Federal Reserve financing of states and cities do not have to close down the MLF to prevent states from borrowing. Local leaders—habituated by the lessons of the infamous fiscal crises of U.S. cities in the 1970s and of Detroit during the global financial crisis—appear all too willing to begin cutting their payrolls rather than finding creative solutions to avoid austerity.
Even after the prospect of receiving federal grants has grown remote, local governments who can borrow favorably from private capital markets have often been loath to do so. As Amarnath explains, “There are a lot of cities that are just kind of resigned to the fact that, ‘I’ve got this balanced budget requirement. I can’t issue debt. The voters will kill me if I try to think around this way.’”
When New York City Mayor Bill de Blasio tried to challenge this type of thinking—asking the state legislature for greater borrowing authority to carry the city through the recession—both Democratic New York Governor Andrew Cuomo and the New York Times editorial board stepped up to enforce conventional wisdom and blast the mayor’s proposal. “Before Mr. de Blasio adds billions to the city’s debt sheet—or lays off thousands of workers—he needs to find savings,” the Times wrote. In November, de Blasio went on a layoff binge.
New Jersey, where first-term Governor Phil Murphy was elected on a broadly progressive platform, provides a different model. In May, new revenue projections adjusted for the pandemic-induced recession showed the state faced a $10 billion shortfall over the next calendar year, and local commentators assumed the state government would have to cut back spending accordingly, as New Jersey’s 1947 Constitution requires an annually balanced budget. Instead, Murphy and the Democrats in the state assembly passed a law in July allowing the governor to borrow up to $10 billion in 35-year bonds to cover the gap. State Republicans argued the law was unconstitutional, but Murphy cited a clause in the state’s constitution allowing government borrowing “to meet an emergency caused by a disaster or Act of God,” arguing that the pandemic itself represented such providential misfortune.
One specific arena in which federal lending could help ward off painful cuts is education. According to the Bureau of Labor Statistics, public school teacher employment, after a brief and partial late-summer recovery, is already collapsing. Put simply, this back-to-school season has seen one million fewer teachers employed in our public schools than before. Likewise, across the country, public university systems—which are the largest employers in California, Iowa, and Maryland—are already announcing layoffs and freezing salaries. In this situation, the recovery is poised to slow, with austere outcomes for the nation’s working-class majority.
Proactive maneuvers could help states and cities using federal lending avoid such cuts. Amarnath argues, “One thing that could really help is a really well-staffed Treasury Department, particularly in the Office of Domestic Finance—people who are really committed to helping a lot of these state and local governments start to figure out the legislative workarounds [to balanced budget requirements] and to be able to issue debt through the MLF.” The Treasury under Mnuchin has remained understaffed compared to the historical norm, but if Biden extends his vow to “build back better” to the department, with the mission of combatting austerity, Amarnath believes it could make a significant difference.
The Fed must do its part, however. Under the guise of a technical discussion about liquidity and bond markets, the Treasury and the Federal Reserve’s Board of Governors are making crucial political decisions about how government will shape the recovery. While the Fed has historically been reticent to intervene in fiscal policy or serve as a development bank, the Cares Act has given it a mandate to respond to the devastating economic impact of the pandemic and specifically to assist cities and states. The decision to do so only on punitive terms is one that can and should be changed. The number of public school teachers that are employed in your community next fall may well depend on it.
Photo credit: DonkeyHotey / Wikimedia Commons.