A little-noticed provision of the revised Heroes Act which passed the House on Oct. 1 might destroy the U.S. municipal bond market. Although this may be a desirable outcome to proponents who would like to free state and local government from the costs and constraints associated with issuing bonds, such a radical change at least merits a debate.
The legislation threatens to eliminate the municipal bond market by expanding the Federal Reserve’s Municipal Liquidity Facility. The MLF was created by the Federal Reserve as an emergency backstop when the municipal bond market temporarily froze up at the start of the COVID-19 crisis in March. Under its current rules, MLF offers government borrowers financing for up to three years at varying interest rates that depend on the entity’s bond rating. For most municipal market borrowers, interest rates quoted by the Fed are higher than market yields. As a result, only two relatively distressed borrowers, the State of Illinois and the New York Metropolitan Transportation Authority have taken advantage of MLF thus far.
The municipal market regained its footing in late March and has met the needs of most other public sector borrowers at near record low rates.
Section 801 of the new Heroes Act (HR 925) would increase the maximum borrowing term to ten years and lower the interest rate for all government borrowers to 0.25 percent — regardless of credit rating. Since no state or local government can borrow for ten years at such