On April 9, the Federal Reserve announced the creation of the Municipal Lending Facility (MLF), aimed at allowing state and local (S&L) governments access to credit so that they may continue to function in these hard times.

Why it’s important

S&L governments are suffering serious loss of revenue on all fronts during the crisis. For example, as people spend less, sales tax revenues fall. As people are laid off, payroll tax revenue and income tax withholding revenue fall. As businesses take losses, business income tax revenues fall. Property tax revenue might not be paid on a timely basis.

At the same time, fixed costs are remaining consistent, and variable costs like unemployment spending and healthcare expenses are rising. S&L governments are the largest single cohort of employment in the US; together with healthcare, they account for nearly one quarter of all nonfarm employment. These governments are trying to keep their employees on payroll and maintain first-responder efforts (police, fire, medics) in the face of sharp revenue declines and rising expenses. The MLF can provide S&L governments with access to credit, helping to keep them operating during a liquidity crisis, when investors may fear buying municipal securities.

So, for the first time, the Fed is providing liquidity to S&L governments. We don't think the Fed likes the precedent, but we are in uncertain times. The MLF will buy up to $500 billion of municipal securities with a maturity of 24 months or less. Remember, the Fed is providing liquidity, not gifts. S&L governments will have to repay any funds they receive from the MLF. That is very different from various subsidies that Congress has granted to S&L governments.

Why it may not be enough

The aim of the MLF is to preserve S&L governments from a cash crunch, so that any possible recovery can be fast and strong when containment measures are lifted. This program is also aiming to limit payroll losses, helping governments, businesses, and households weather the crisis.

We believe the Fed cannot do all the heavy lifting by itself. S&L governments must balance their budgets. While loans might temporarily relieve a cash shortfall, they will not make up for lost revenues. We believe S&L governments need direct subsidies (not loans) from the federal government. Without fiscal assistance, many S&L governments might have to start cutting services, employment, or both to balance their budgets. We are concerned that potential cutbacks in S&L spending could act as a drag on the recovery.