INSUBCONTINENT EXCLUSIVE:
By Brian ChappattaAlmost 10 years after the Great Recession ended, the growing threat of a new economic slowdown raises a troubling
loaded with assets bought to fight the 2008 crisis, do they have the tools to respond This column is one of five looking at that
question.
US state governments suffered major damage from the last recession 10 years ago
During the second quarter of 2009, the final months of the downturn, personal income taxes tumbled 27 per cent from a year earlier
At the same time, expenses grew as enrollment for Medicaid and state unemployment insurance soared, while crumbling asset prices suddenly
left public pension systems with massive shortfalls relative to their liabilities
In statehouses across the country, money was tight, to say the least
State government employment remains below its pre-financial crisis peak
Public pension plans are still largely in a sea of red ink, with an overall shortfall of $1.4 trillion at the state level, and even those
with an acceptable level of assets are just one bear market away from the brink
short by $2 trillion over the next several years.
As the Federal Reserve contemplates what the next recession might look like, and what
tools it has available to combat it, the fiscal health of US states is likely to emerge as a significant roadblock to any economic
workers to their payrolls
That means either sharp cutbacks in public services, higher taxes or shortchanging pensions
None of those options will stimulate growth.
The easy answer would be directing more cash from the federal government to the states
But the 2009 stimulus program already transferred an unprecedented amount of money into state coffers and the results were middling at best
That means it might be up to the the Fed to get involved in the $3.8 trillion municipal-bond market to give states a much-needed boost
The central bank can only do so much during a downturn to get companies and individuals to borrow
But by directly backing states, it will immediately allow them to make payroll, start on new infrastructure projects, or both.
First, to get
the obvious out of the way: The Federal Reserve Act largely prohibits such a move, only allowing the central bank to purchase munis with
maturities up to six months
That means any such plan would still require some political will to amend the law.
But if the Fed could gobble up toxic assets in the wake
officials need only look to the European Central Bank, which owns a portfolio of sovereign bonds, including debt of low-rated Italy,
They are to triple-A Germany what Connecticut, Illinois and New Jersey are to states with top grades like Georgia, Maryland and Utah
up distorting new offerings and secondary trading
Demand for tax-exempt debt is already on the rise because of new limits on state and local tax deductions
The scarcity of bonds has gotten so severe that some investors are embroiled in a bitter lawsuit.
For the Fed to be most effective, its
bond-buying program should be well-defined and narrow in scope
The most obvious parameter: It could only buy state-level general obligations
This reduces the number of different bonds it owns, while leaving it to elected governors to distribute the benefits to cities and
towns.
The more complicated factor is exactly how the Fed would buy these bonds
The strongest form of intervention would be having states place debt directly with the central bank at a low fixed interest rate, giving the
states a major influx of cash at a minuscule cost 1
This option is almost like a federal grant, only they have to pay back the principal when the debt matures
bond sales by pledging to take down any part of an offering that exceeds a pre-determined yield level
This would give muni investors a chance to still purchase some of the securities, though at lower yields than the market might otherwise
any given period and how much from each state
But as far as the proceeds, most uses seem like fair game, aside from subsidizing a large corporation or a sports franchise
pension payments.
A similar sort of idea has been proposed before, though not involving the Fed
In 2008, Philadelphia, Atlanta and Phoenix asked the US Treasury for $50 billion on behalf of cities to spend on infrastructure and loans
lasting as long as a year to aid cash flow
After all, no political party at the federal level even pretends to care about budget balance anymore
To their credit, many have chipped away at long-term problems.
When the next recession comes around, though, they might not have the tools
The Fed should stand ready to provide that boost.
