The Federal Reserve emergency-lending program deserved to die
Last week, Democrats accused Team Trump of acting like sore losers in ending a $500 billion emergency-lending program for states and cities before Joe Biden takes office. Whatever the White House’s motives, it’s time to shut down this program. More borrowing can’t fix its broke beneficiaries, not least the Metropolitan Transportation Authority.
In March, when Congress passed the CARES Act, lawmakers and the president were justified in approving federal lending to states and cities. Private lenders feared that tax revenues would plummet, making it harder for states and cities to repay their existing debt. They thus demanded double the pre-pandemic interest rate on the average municipal bond, to make up for the additional risk.
But since then, municipal-bond markets have calmed down. Rates are lower than ever.
Why? First, the Federal Reserve has cut overall interest rates to record lows, meaning everyone, including states and cities, can borrow for cheaper. Second, the $2 trillion in aid to unemployed Americans and small businesses worked, keeping consumer spending stable. Add the fact that relatively few white-collar workers, who pay the most in income taxes, have lost their jobs.
The result: a smaller state tax loss than many predicted. According to the Urban Institute, from April to September, states lost an average of 5.3 percent of their tax revenue, or $27.3 billion.
Considering that the CARES Act provided $150 billion in grants — no need to pay back! — to states and localities, most could muddle through. If they were to borrow for day-to-day expenses — as opposed to long-term capital investments, the normal reason for borrowing — the biggest impediment isn’t high interest rates in bond markets. Rather, it’s state constitutions that prohibit such debt.
So why did the CARES Act authorize the half a trillion dollars in Fed lending directly to state and local government entities?
It’s simple: A few states were in a lot of trouble before COVID-19. Make that one state: Illinois.
Even before the pandemic, Illinois had a near-junk credit rating, making it barely eligible to issue debt. The state’s biggest problem is that for decades, it promised pension benefits to government workers that it could never pay. Its pension debt is nearly $150 billion, nearly four times the size of the state budget.
Illinois can’t borrow in private markets, not at interest rates it can pay. So it has borrowed $1.2 billion from the Fed’s emergency program and will borrow another $2 billion before President Trump shuts it down. Yes, Illinois must pay a penalty interest rate, under the Fed’s program guidelines, more than 3 percent annually, when the market rate for healthy states is well below 1 percent.
Yet this form of payday lending has hardly instilled market discipline. Illinois hasn’t taken any concrete steps to cut spending.
The Fed debt comes due in a couple of years. Does anyone think the situation will be fixed then?
After Illinois, the Fed’s only payday-lending customer is . . . New York’s MTA.
The state-controlled authority is hardly a paragon of fiscal virtue. But its COVID problem is entirely different from Illinois’: The pandemic has killed ridership. Subway ridership is below 30 percent of normal. So billions of dollars in fares have disappeared. The MTA, too, has borrowed $3.4 billion from the Fed.
Yet it, too, must pay a penalty rate. If the point is to help public entities through a crisis they didn’t create, why punish the MTA with a high interest rate? By 2023, when the MTA’s debt comes due, it plans to take out more debt to repay the Fed — and will owe $150 million in annual interest on these bonds, for decades.
What if ridership is nowhere near normal? That’s billions that could have gone toward subway and bus service.
The Fed’s program served its purpose, in tamping down a temporary crisis in bond markets. But for specific cases, it misses the mark. A broke state like Illinois needs to cut its budget. Transit agencies missing their passengers need grants, not more debt. And yes, the MTA needs to reform its labor practices — something the Fed program doesn’t achieve.
Congress needs to decide that saving big-city transit is worth it. Debt may keep transit on life support, but the last thing New York needs in 2023 is an MTA on life support.
Nicole Gelinas is a contributing editor of City Journal.
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