While more than 63% of Americans live in cities, the vast majority of city residents live in communities with populations of 300,000 or less[i]. Cities large and small face financial risks from COVID-19 and the challenge of mitigating its spread. They face extra and increasing costs for essential public safety and health and lost tax revenues that rely on consumer spending, which has paused as a result of stay-at-home measures. While the Federal government has outlined and delivered resources to states and larger cities and counties[ii], it can take the following additional three actions to help smaller communities where most Americans live to reopen and support economic recovery:
- Revise the Fed’s Municipal Liquidity Facility (MLF) to enable more cities to access credit directly.
- Raise the bank-qualified municipal bond cap from $10M to $30M and index for inflation to expand borrower options.
- Restore tax-exempt advance refundings to make it easier and cheaper for communities to refinance debt.
Revise the Fed’s MLF
As currently drafted, the MLF is intended to be a “lender of last resort” for states, cities, and counties that face significant expenses or revenue shortfalls due to COVID-19. It is authorized to lend up to $500 billion in loans that allow the borrowers to spread the financial impact of the COVID-19 disruption over a longer period of time, up to 36 months. Borrowing rates are intended to be higher than those most municipal bond issuers could receive in the public markets. However, if concerns about the creditworthiness of cities continue to grow, the MLF lending rates may become more attractive.
Unfortunately for medium-sized and smaller cities, the program includes a key limitation: The list of “Eligible Issuers” who can access the loans only includes states, counties with a population over 500,000, and cities with a population over 250,000 (states without any qualifying cities or counties may designate two local governments for direct access[iii]). Any other community facing a fiscal emergency would be forced to request that its state government borrow on its behalf, which in most states would require new legislation and/or voter approval to authorize borrowing on behalf of cities[iv].
To address this problem, the Fed can adjust the program’s eligibility criteria to expand the list of Eligible Issuers, as it has already done twice. In addition, it could broaden the eligibility for state-facilitated loans to cities by replacing the “state guarantee” requirement with other ways for borrowers to demonstrate their creditworthiness. These steps would broaden the criteria to support communities with populations of 250,000 or less, which is where it will likely be needed the most.
Raise the Bank-Qualified Municipal Bond Cap
Congress can help smaller cities improve their access to the capital markets by raising the cap on bank- qualified municipal bonds. Small municipal bond issuers who borrow less than $10 million per year can benefit from selling bank-qualified municipal bonds, which are typically sold to commercial banks who are eligible to receive a tax benefit when they buy and hold these bonds. This tax provision expands the market for that debt, and when more investors are vying for their debt, cities typically benefit with a lower interest rate.
The current $10 million cap was established under the 1986 Tax Reform Act, and (with the temporary exception of the American Reinvestment and Recovery Act in 2009) has not been adjusted for inflation. Lifting the cap to $30 million today and indexing for inflation going forward would be a major benefit for smaller cities, allowing them to borrow more easily at more attractive rates.
Restore Tax-Exempt Advance Refundings
In an advance refunding, a city can sell new bonds to refinance existing debt. The proceeds of the new bond sale are placed into an escrow account until the older bonds can be repaid under the terms of the original bond. When rates have fallen, an advance refunding can reduce a city’s debt service budget. This approach can also benefit communities facing severe short-term financial stress by allowing them to adjust the debt payment schedules, providing additional time and flexibility to deal with sudden spikes in expenses and unforeseen revenue losses. Tax-exempt advance refundings were eliminated in the 2017 Tax Cuts and Jobs Act, but a bipartisan coalition of lawmakers has signed on to support restoring that authority[v]. Congress can restore tax-exempt advance refundings and help localities and taxpayers save money.
About the Author
David Park is Program Director of NLC’s Center for Municipal Data & Analytics.