MNI POLICY: Fed's Muni Repricing Seen as Drop in the Bucket

The Federal Reserve's repricing of its Municipal Liquidity Facility is seen as only a drop in the bucket that will not address the underlying state and local budget woes.

"To the extent that Congress is bogged down I think the Fed's action makes sense. It's not a substitute by any stretch of the imagination," said Gary Stern, former president of the Minneapolis Fed from 1985 to 2009.

The Fed said on Tuesday it would reduce the rates it charges cities and states seeking short-term loans from an emergency lending program that has seen little take up so far. The Fed will reduce by 50 basis points the interest-rate spread on tax-exempt notes, and it will also reduce the amount by which rates for taxable notes are adjusted relative to tax-exempt notes.

"The extent of what it accomplishes should be modest and maybe it would have been unnecessary if Congress had acted," said Stern.

The change to the Fed's muni facility comes as talks over fiscal policy on Capitol Hill have broken down with aid to states and cities emerging at the center of the impasse.

House Democrats have pushed for USD915 trillion in aid, but Senate Republicans last month didn't include any such relief in their proposal although Republican negotiators now say they would be willing to add an additional USD150 billion in aid on top of the USD150 billion in March legislation.

"If we don't get some aid to state and local governments they'll deal with it but they'll deal with it by cutting back," Dallas Fed President Robert Kaplan said on Wednesday to the Lubbock Chamber of Commerce, adding that he has been told by local leaders that they expect to continue to layoff staff.

"We really don't want state and local governments to be cutting back at a time you're trying to grow out of a deep hole," he added.

The bipartisan National Governors Association has requested USD500 billion in unrestricted state aid and continues to urge Congress and the White House to reach a quick resolution in the talks.

The Fed so far has purchased only one note through the muni program supporting the state of Illinois to the tune of USD1.2 billion at a rate that in June was more than 1ppt below the rate at which it was previously able to access markets in May.

The rates the Fed charges are on a sliding scale based on the issuers' bond ratings.

Its relatively high spreads limit the program's appeal for issuers and they have by and large been able to get lower rates in the open market.

That is the way it's designed, the Fed's Kent Hiteshew said in May. "The MLF pricing has been established to serve as a backstop, not as a first stop," he said.