Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisenthal and I'm Tracy Allowin. Tracy, do you
Speaker 1: remember you said on a recent episode something akin to
Speaker 1: we finally covered all of the different aspects of this crisis.
Speaker 1: I knew you were jotting that down in your memory
Speaker 1: and it was going to come back to haunt me.
Speaker 1: I stand by it. I think we've hit the really
Speaker 1: big ones, but I know you're going to pull another
Speaker 1: one out of your pocket right now. I think of
Speaker 1: like twenty more to come. I said the major strains
Speaker 1: in the financial system. I caveated it. You can't say
Speaker 1: that there are forty major financial strains, but you're going
Speaker 1: to I think I think they're white. I think that
Speaker 1: might literally be already more major ones. But nonetheless, we
Speaker 1: definitely have not hit all the major ones, and so
Speaker 1: I think that today's episode will be one that I
Speaker 1: think sort of unquestionably counts as major even if you
Speaker 1: know the number of remaining ones are still TPD alright,
Speaker 1: fair enough, and I think I know which one it is.
Speaker 1: It has to be the UNI market, right, Yeah, so
Speaker 1: absolutely so. Due to the nature of the crisis that
Speaker 1: we're seeing we have a situation in which a lot
Speaker 1: of the costs, particularly on the public health side, are
Speaker 1: falling on state and local authorities. At the same time,
Speaker 1: their tax revenue is rapidly drying up because there's so
Speaker 1: little economic activity going on within these state and local
Speaker 1: taxing authorities. And so what is a major employer of
Speaker 1: many people all in a major source of economic stability.
Speaker 1: They're all simultaneously running into rapid budget problems. And we've
Speaker 1: already seen just in the early days, major wave of cuts, layoffs,
Speaker 1: and so forth from cities, towns, and states around the country. Yeah,
Speaker 1: and I think from a market's perspective, I remember seeing
Speaker 1: a couple of headlines that basically said we didn't have
Speaker 1: any new issuance new muni bond issuance in March, and
Speaker 1: we had a bunch of outflows, I think, the most
Speaker 1: outflows on record from muni bond funds. So really we
Speaker 1: have this big investor exodus. And as you point out,
Speaker 1: if tax receipts are expected to fall and at the
Speaker 1: same time states can't issue as easily as they once
Speaker 1: could in the muni bond market, then that all adds
Speaker 1: up to a pretty big financing crunch at exactly the
Speaker 1: time where you wouldn't want to get that right is
Speaker 1: a financing crunch, and then that leads to an economic crunch,
Speaker 1: because you know, we saw during two thousand and eight
Speaker 1: two thousand nine financing constrained municipal authorities. They had to
Speaker 1: cut a lot of spending for the same reasons as now,
Speaker 1: and it's them years and years to recover that law
Speaker 1: of spending. And so you know, when we think about
Speaker 1: the sort of longer term ramifications of this and the
Speaker 1: damage that these last several weeks will do to the
Speaker 1: economy potentially for years to come, state and local finances
Speaker 1: is a huge problem that we're facing. Yeah, and I
Speaker 1: have to say, the only thing I really remember from
Speaker 1: the muni market is Meredith Whitney making that big call
Speaker 1: many many years ago. Do you remember that where she
Speaker 1: predicted a bunch of defaults, I think hundreds of defaults
Speaker 1: across the muni space, And of course that didn't come
Speaker 1: to pass. So I'm really interested in in returning to
Speaker 1: this topic. It's been a while. Yeah, the default didn't happen,
Speaker 1: It was more just played out on the real economic
Speaker 1: side and a slow return to hiring. So anyway, on
Speaker 1: today's episode, we're going to dive into the state, the
Speaker 1: state of state and local municipal finance, how much strain
Speaker 1: there on, what are the ramifications of a strain, and
Speaker 1: what can possibly be done to alleviate that pressure. And
Speaker 1: today we have three guests. This is a first time
Speaker 1: we've ever had this on the podcast where we've had
Speaker 1: three guests at once, so it could get a little crazy,
Speaker 1: but all three of them have been doing a lot
Speaker 1: of writing about this crisis and how it can be
Speaker 1: addressed from the sort of federal reserve side of what
Speaker 1: the Fed can do to help ease the problem, and
Speaker 1: what the Treasury can do. So I'm going to introduce
Speaker 1: our three guests today are Skanda Amarnav, director of Research
Speaker 1: and Analysis and employee America, Alex Williams, he's a grad
Speaker 1: student at the Levy Institute, and Yakov Fagan, he's an
Speaker 1: associate director of the Future of Capitalism Program at the
Speaker 1: Burgrowing Institute. I want to thank them all so, Sconda,
Speaker 1: thank you for joining us, Thanks sharing me on, Alex,
Speaker 1: appreciate you coming here, thanks for having me, and uh Yakov,
Speaker 1: thank you, thank you too. I want to introduce all
Speaker 1: three of you so that people could recognize your voices
Speaker 1: in advance. So, uh, to get started, Asconda, I'll start
Speaker 1: with you. Just talk to us a little bit about
Speaker 1: what we've seen so far from your perspective. Your talk
Speaker 1: to us about what you do with Employee America and
Speaker 1: how the initial wave of financing stress that we've already
Speaker 1: seen at the state and local level is sort of
Speaker 1: playing out in the economy. Sure, so employ America organization
Speaker 1: is focused on a combination of tighter labor markets sustainably,
Speaker 1: and to get there, obviously it requires fighting recessions aggressively
Speaker 1: and mitigating their costs. The costs of recessions aren't even
Speaker 1: just seen in recessions or the official and be our
Speaker 1: dates UM, especially when you think about like the weakness
Speaker 1: of the proprior business expansion, you think about the growth
Speaker 1: and the weakness in UM getting unemployment down. So we
Speaker 1: had high on the ployment for about three years and
Speaker 1: that was in large higher nine three years. I was
Speaker 1: longer than that, but we had state and local austerity
Speaker 1: UM that was helped sort of keep growth low and
Speaker 1: to keep unemployment high for a lot longer. And what
Speaker 1: we're seeing now is state and legal government's already starting
Speaker 1: to announce a lot of job cuts similar to what
Speaker 1: we saw around two thousand nine, and part of that
Speaker 1: right now, it's these are not fully in motion just
Speaker 1: yet because states built up um rainy day funds over
Speaker 1: the past expansion and they're now running them down. But
Speaker 1: it's not gonna last that much longer just because of
Speaker 1: the scale of the shock. So you have states that
Speaker 1: are saved a lot, saved up a lot, didn't really
Speaker 1: spend much during the past expansion, but are still in
Speaker 1: a pretty fragile position in terms of being able to
Speaker 1: manage this shock because they are budget constrained, as you mentioned,
Speaker 1: and I think and it's just that they're not able
Speaker 1: to sort of finance their way through it the way
Speaker 1: the U. S. Treasury and the federal government can. So
Speaker 1: I have a dumb question, and this is partly because
Speaker 1: I'm outside of the US at the moment and I
Speaker 1: haven't been following a lot of these dynamics as closely
Speaker 1: as you all have. But there seems to be an
Speaker 1: assumption here that state governments are on the front line
Speaker 1: of the coronavirus pandemic as well as the economic fallout.
Speaker 1: Why is that the case? Should states actually be the
Speaker 1: first line of defense and what's the role of the
Speaker 1: federal government here? So so part of this is a
Speaker 1: sort of the vestiges of a more federalist system in
Speaker 1: the past. So a lot of administration still ends up
Speaker 1: occurring at the state local level, even though the financial
Speaker 1: levers are still controlled in d C. So there's some
Speaker 1: there's a bit of a mismatch there that that's going on.
Speaker 1: But UM, should more of that be done at that
Speaker 1: be centralized, I think for a lot of these types
Speaker 1: of coordination and collective action problems as we see it,
Speaker 1: sort of procuring the necessary equipment and those are all
Speaker 1: things that should clearly be centralized in some way. But
Speaker 1: the reality of this is just that there's a lot
Speaker 1: of safety net programs public services UM that are typically
Speaker 1: in higher demand during a crisis like this in terms
Speaker 1: of the public health crisis and the economic crisis, and
Speaker 1: those are still connected at the state, state government level,
Speaker 1: the local government level, and yet they don't really have
Speaker 1: the flexibility precisely when you need it UM. So that's
Speaker 1: kind of what and so it ends up being collateral
Speaker 1: damage in the process is there's a lot of UM
Speaker 1: cuts to UM Andrew Cuomo had mentioned, had announced very
Speaker 1: recently the Governor of New York cuts to medicaid, um
Speaker 1: hiring freezes, plans for big expensure cutbacks in the coming year.
Speaker 1: So you've already started to see a lot of these
Speaker 1: announcements come out um that they're going to have to
Speaker 1: take an act to other types of economic activity a
Speaker 1: public sector performs. Yeah, I just want to add in that.
Speaker 1: You know, yes, it might be better that certain things
Speaker 1: are centralized, but this is the system we live in
Speaker 1: with the United States, and there are some advantages to
Speaker 1: governmental redundancy, especially in a world in which regional cycles
Speaker 1: are very disconnected in the United States between various regions
Speaker 1: and are driven by global shocks more generally. But a
Speaker 1: particularly perverse sort of aspect of the way that it's
Speaker 1: set up now is is Scanta mentioned, you know, cuts
Speaker 1: to Medicare and custom Medicaid right now, These programs at
Speaker 1: the federal level are actually set up to be mechanically
Speaker 1: pro cyclical at this point, where if a state government
Speaker 1: cuts its Medicare funding or its Medicaid funding, those are
Speaker 1: funded at the federal level through matching grants. So every
Speaker 1: dollar that they cut due to lost tax revenue or
Speaker 1: excess take up in other spending programs loses them an
Speaker 1: additional dollar of federal spending on those programs, which is like,
Speaker 1: there are lots of these sorts of little things, you
Speaker 1: know in this system of distributing, you know, federal abilities
Speaker 1: to state levels that you know have these sorts of
Speaker 1: perverse outcomes. So yeah, I want to go back to
Speaker 1: what you were just saying about the sort of governmental
Speaker 1: redundancy and the appeal of that. Like, we have this
Speaker 1: federal system of states have a lot of autonomy, cities
Speaker 1: have various authorities. We have it's a very it's not
Speaker 1: like other countries where maybe it's sort of all run
Speaker 1: down by one sort of centralized chain of command. That's
Speaker 1: our political system. What in a crisis like this, what
Speaker 1: do you see as the sort of advantages versus disadvantages? Well,
Speaker 1: I think we all know about the disadvantage, and I
Speaker 1: do think kind of from my point of view, it's
Speaker 1: still more disadvantage than advantage. But on the other hand,
Speaker 1: we when we've seen that the federal government, for whatever
Speaker 1: reason you attribute to it, hasn't been very swift in
Speaker 1: respond to this. But you've also seen that some of
Speaker 1: the states, particularly you know, especially up in Washington here
Speaker 1: in California, have been much faster at responding to this
Speaker 1: than the federal government. And you know, God, you know,
Speaker 1: God help us. If they hadn't been right, it could
Speaker 1: have been much much worse. So there is always some
Speaker 1: advantages to redundancy. But one one of the problems that
Speaker 1: I point out in the in the working paper that
Speaker 1: I put out though, is that the last sort a
Speaker 1: couple of months, you know, because of that governmental redundancy,
Speaker 1: the problem is is that there's redundancy in you know,
Speaker 1: ability to execute policy, but not inability to provide financing.
Speaker 1: So you have the situation where you know, these states
Speaker 1: know that if they enact these broad lockdowns like that's
Speaker 1: going to you know, essentially wreck their finances and so
Speaker 1: all of you know, one way of looking at basically
Speaker 1: what happened through January, February and March is that you
Speaker 1: basically had a whole bunch of these different state governments
Speaker 1: effectively playing chicken, where the you know, sooner they locked
Speaker 1: things down, the sooner they'd lose revenue and the less
Speaker 1: money they'd have to treat the aftermath. But the later
Speaker 1: they waited, they had more revenue, they'd have, but the
Speaker 1: worse of an outbreak they'd have. So it's this kind
Speaker 1: of you know, sort of distributed game of chicken. Because
Speaker 1: of this non integration of you know, budgetary and political abilities,
Speaker 1: it's a perverse incentive system for dealing with something like
Speaker 1: a pandemic. But since you mentioned that working paper, maybe
Speaker 1: we should talk a little bit about what you think
Speaker 1: would actually start to solve the problem of UM this
Speaker 1: sort of financing crunch in the muni market or in
Speaker 1: the state financial system. So I'm gonna let Yakov and
Speaker 1: Scanada talk about the community market because they, you know,
Speaker 1: are done more of the work there. But the proposal
Speaker 1: that I put forward basically looks at the fact that
Speaker 1: UM states have a you know, states tax revenue elasticity
Speaker 1: with respect to GDP. So basically, how much the state
Speaker 1: tax revenues grow as GDP grows is just around one
Speaker 1: or just a little bit below one in the long term,
Speaker 1: so states face a shrinking tax base, you know, long
Speaker 1: term without raising tax rates. But at the same time,
Speaker 1: in the short run, they have a very high elasticity
Speaker 1: with respect to unemployment. So if you know, unemployment falls
Speaker 1: by one point, you know, tax revenues will fall by
Speaker 1: one point five points or one point eight points. And
Speaker 1: so what I sort of did with this thesis was
Speaker 1: to come up with a sort of you know, you
Speaker 1: guys have had Claudia Sama on talking about the Som
Speaker 1: rule for recessions and for getting money out uh, and essentially,
Speaker 1: you know, state governments are subject to these same constraints
Speaker 1: because their balanced budget constrained entities. So the idea was
Speaker 1: essentially to take that and then move it over to
Speaker 1: the space of tax revenue replacement per unit unemployment. And
Speaker 1: so the idea was that it would create sort of
Speaker 1: an autonomous financing facility that didn't require you know, specific
Speaker 1: legislative discursements, that would support state revenues during a downturn
Speaker 1: that generally is you know, not caused by anything that
Speaker 1: happened in the states. The states, you know, are subject
Speaker 1: to regional and national and global trends much of the movement,
Speaker 1: and state level unemployment is not caused by state level
Speaker 1: policy per se. And so the idea behind this proposal
Speaker 1: would be that you know, for every you know, when
Speaker 1: you have something like the SOMB rules, so if unemployment
Speaker 1: goes up half a percentage point, over its three month
Speaker 1: moving average. Anytime that is triggered, it looks at that
Speaker 1: like it looks at the past a year or so
Speaker 1: of unemployment and takes that as a baseline, and for
Speaker 1: every percentage point that unemployment goes above uh that baseline rate,
Speaker 1: this facility would essentially transfer eight percent of the previous
Speaker 1: year's tax receipts like for that period to that state
Speaker 1: as a block grant um for the states to basically
Speaker 1: use for general revenue. Part of this is because states historically,
Speaker 1: when they are trying to close budget gaps, have you know,
Speaker 1: undertaken sort of more aggressive financing maneuvers, things like securitization
Speaker 1: of future revenues or things like privatization of existing services.
Speaker 1: But when you're in a financial crisis, or when you're
Speaker 1: in a crisis that has financial dimensions, even that sort
Speaker 1: of really aggressive dealmaking basically becomes impossible and you just
Speaker 1: need something in order to stop the bleeding basically. And
Speaker 1: so a big blanket policy like this that gives states
Speaker 1: wide latitude to deal with the causes of the crisis,
Speaker 1: I think would go a long way towards remedying the
Speaker 1: sort of perverse incentive system. Well, why don't we talk
Speaker 1: about from more of the market side. I mentioned that
Speaker 1: we've seen record outflows from a bunch of muni bond funds.
Speaker 1: We've seen strings in the market. I think almost no
Speaker 1: new issuance in the month of March. What would help there, Well,
Speaker 1: Scanda and I argue that what would really help there
Speaker 1: would be of the Federal Reserve intervene much it does
Speaker 1: in other markets and backstop the market and purchase some
Speaker 1: municipal bonds. I just just attack on there. At Yakoff's point, UM,
Speaker 1: we've seen already that they've been willing to engage in
Speaker 1: direct purchases for UM investment grade corporate funds, including buying
Speaker 1: the l q D E t f UM. So I
Speaker 1: think in this situation, given the sort of public interest
Speaker 1: need alongside UM, the AH the same sort of budget
Speaker 1: constraint financial constraint problem that sort of emerges in these
Speaker 1: types of crises, UH direct purchases of investment grade UM
Speaker 1: state and local government debt. It's a little harder because
Speaker 1: the market is more fragmented, but it's something that we
Speaker 1: I think at least at an additional degree of freedom
Speaker 1: to the more comprehensive fiscal solution that Alex is proposing
Speaker 1: in his working paper. So let's let me ask you
Speaker 1: further about that scondin then others can take it, because intuitively,
Speaker 1: it's okay, the FED, in theory, could buy municipal debt
Speaker 1: directly or the secondary market from the states or the
Speaker 1: towns to backstop their finances, and technically from a um
Speaker 1: from a mechanical standpoint, it's clear how the FED could
Speaker 1: do that because it creates money. On the other hand,
Speaker 1: there are obvious concerns about sort of democratic accountability that
Speaker 1: sort of reminds me of in Europe when they're like, well,
Speaker 1: if we just started back stopping all the debt from
Speaker 1: the different countries, then what is to limit their spending
Speaker 1: going forward? And things like that, and so the you know,
Speaker 1: Draggy and the Eurozone crisis proposed proposed that thing. We're like, okay,
Speaker 1: you can get back stopping from the ECB, but you
Speaker 1: have to submit to certain conditions regarding your spending. How
Speaker 1: should the FED navigate that issue now such that it
Speaker 1: can backstop state and local authorities without necessarily UM writing
Speaker 1: them a blank check? I think so one of the
Speaker 1: parameters to the proposal Yakov and I had put together
Speaker 1: a few weeks ago, was to make it sort of
Speaker 1: time dependent. I think there were aspects of the as
Speaker 1: of the drug EASA UM yes M proposal in one
Speaker 1: sense that helped make sure there was access to financing,
Speaker 1: but there was also sort of the pitfall that it
Speaker 1: also encouraged a lot of austerity that we can which
Speaker 1: is the exact opposite of which is, yeah, the exactly
Speaker 1: opposite if we anter something about the big picture UM
Speaker 1: problem that we really don't want to UM to exacerbated.
Speaker 1: Aside from sort of the pro pro cyclical aspect of
Speaker 1: st local government spending is we want these governments to
Speaker 1: spend what's necessary for the public health response, not to
Speaker 1: sort of meet arbitrary budget constraint that could be loosened
Speaker 1: with the right policies in place of the Federal Reserve
Speaker 1: of the federal government. So in this case, I don't
Speaker 1: think that the answer is to sort of make them
Speaker 1: commit to some austerity policy for the receivable future. What
Speaker 1: should be this should be constrained in our proposal is
Speaker 1: make it sort of the timeline should be consistent with
Speaker 1: the national crisis. Right that these is uh like the
Speaker 1: FEDS ability to effectively lend to state governments should be
Speaker 1: something that's available for a limited time, right, So, just
Speaker 1: as the commercial paper funding facility and two thousands, eight
Speaker 1: and nine was actually was open till February UM, so
Speaker 1: the really book ended the worst parts of the financial
Speaker 1: crisis and gave some time for corporations to roll over
Speaker 1: short term debt until we had gotten through the coverst
Speaker 1: period of the global financial crisis in the Great Recession.
Speaker 1: Something similar could be calibrated here in terms of making
Speaker 1: financing available to the state governments. For we call it
Speaker 1: approximately twelve months from the worst point in terms of
Speaker 1: the economic impact from this crisis. So we could take
Speaker 1: the peak on employment rate, or we could take um
Speaker 1: some other economic parameter or public health parameter, or even
Speaker 1: I think one of the things that's also missed in
Speaker 1: these in these discussions about you know, moral hazards for
Speaker 1: providing financing facilities for subnational entities in the US is
Speaker 1: the fact that in the Eurozone, these balanced budget requirements
Speaker 1: are centralized and centrally enforced. They are they are the
Speaker 1: monstric treaty saying you know, this is the space that
Speaker 1: your budgets are allowed to be in. UH in the States,
Speaker 1: in the us. By contrast, they are entirely enforced and
Speaker 1: acceded to at the local level. There are aspects of
Speaker 1: the state constitutions rather than anything in federal law. So
Speaker 1: you wind up having this situation where, um, on the
Speaker 1: one hand, the states are saying, yes, we are doing
Speaker 1: this on purpose, you know, and there's been studies showing
Speaker 1: that this affects muni bond yields in those states, you know,
Speaker 1: in this way and that way. Um, But it's the
Speaker 1: states saying that they're going to do it. But then
Speaker 1: the states also putting themselves in a position basically where
Speaker 1: it's impossible for them to sue basically like an anti
Speaker 1: correlated capital structure, So there's no way they can set
Speaker 1: their sort of financial house so that their financing costs
Speaker 1: get lower when there's a crisis. Because the financing costs
Speaker 1: are done, they're displaced entirely to basically capital accounts. Because
Speaker 1: these states with balanced budgets that only obtains for the
Speaker 1: general revenue account, anything that they do to sort of
Speaker 1: like build infrastructure or do a wide variety of other things,
Speaker 1: they can essentially move off budget in a way that
Speaker 1: like you see, you saw that we talked about the
Speaker 1: mundy blow ups that didn't happen. But one of the
Speaker 1: things that did happen is there were a lot of
Speaker 1: off budget enterprises that did blow up. The Detroit Water
Speaker 1: Authority was a very big one that went on for
Speaker 1: a long time because they had a complicated UH swaps portfolio.
Speaker 1: But states, you know, progressively do that when they securitize
Speaker 1: or when they privatize their revenues in order to make
Speaker 1: up for shortfalls in their general revenue account in a
Speaker 1: given period. They do it by pushing things into these
Speaker 1: capital accounts and into these off budget enterprises that are
Speaker 1: themselves fragile but which operate in the muni markets. So
Speaker 1: backstopping those muni markets does provide a kind of secret
Speaker 1: quasi backstop for you know, state's attempts to relieve themselves
Speaker 1: of their self imposed burden, which is sort of a
Speaker 1: different overall environment from the Eurozone of member states trying
Speaker 1: to deviate and spend more. Yeah, it could just quickly
Speaker 1: tack onto what Alex was saying here. Um, so there
Speaker 1: are balanced budget laws and rules, but as he's just
Speaker 1: pointed out, for each state, there are exemptions in various
Speaker 1: ways in terms of how to adhere or not adhere
Speaker 1: as much to them. Um And I think that sometimes
Speaker 1: it gets lost in this discussion because there's an assumption
Speaker 1: that there is a law and it is airtight, and
Speaker 1: that these states have to just start slashing spending as
Speaker 1: soon as tax revenue falls, and there are ways to
Speaker 1: um manage and maneuver around it that we're probably less
Speaker 1: there was probably less political willingness to explore them in
Speaker 1: the early tens in a way that I think now
Speaker 1: just because of the nature of this, should be explored
Speaker 1: more aggressively. There's also exemptions for certain types of natural disasters,
Speaker 1: exemptions through different types of what they are called the
Speaker 1: special districts that allow for certain types of certain parts
Speaker 1: of the state government to issue debt and not be
Speaker 1: constrained by these sort of arbitrary balanced budget laws and rules.
Speaker 1: M I'm curious, but why did the FED not buy
Speaker 1: muni debt back in the financial crisis of two thousand eight.
Speaker 1: Was it the sort of moral hazard issues that you're
Speaker 1: all alluding to, or was it something more technical, or
Speaker 1: was it just that the crisis didn't really warrant the
Speaker 1: kind of state response that we need now during a pandemic.
Speaker 1: I think I can take that. Um. I think there
Speaker 1: are a variety of reasons. Uh. In Ben Bernacki's memoirs,
Speaker 1: it's noted that two of the vice chairs, and I
Speaker 1: will tell you who they are in a second, because
Speaker 1: I have them written down. UM, I think it was
Speaker 1: it was David Cohen and Kevin Walsh who were most
Speaker 1: skeptical of the proposals. And my understanding and instinct is
Speaker 1: there were several things involved. First of all, the FED
Speaker 1: isn't really familiar with the municipal bond market, and the
Speaker 1: municipal bomb market itself isn't a very deep market. Um.
Speaker 1: They're all kind of which is very unfortunate and one
Speaker 1: of the reasons I do think the FED should be
Speaker 1: boxed stopping this market and working with it, because because
Speaker 1: it just needs to be fixed. Overall, I think there
Speaker 1: was another reason in which it did seem like it
Speaker 1: would be the FED doing fiscal policy, which at the
Speaker 1: time I think there was still a lot of nervousness
Speaker 1: about where building that divide. And the third reason is,
Speaker 1: and I think this is still a reason hasn't happened today,
Speaker 1: is quite frankly, neither the state treasurers nor the Federal
Speaker 1: Reserve board really under stand what each is doing. It's
Speaker 1: very likely that one of the reasons we don't see
Speaker 1: this is if it does assume states can't borrow because
Speaker 1: of balance budget laws. Because and because of those laws,
Speaker 1: what you see is the collateral base of the municipal
Speaker 1: bond market is extremely hard to understand, even for people
Speaker 1: who are very, very seasoned investors in that market. In California,
Speaker 1: we're actual I'm actually doing an exercise that with the
Speaker 1: Californias some people in the California state government looking at
Speaker 1: what could be receivable, and it turns out there might
Speaker 1: be a hundred billion of at least of things that
Speaker 1: we could re uh, we could refinance through that FED
Speaker 1: potential FED window. But it just doesn't look like it's
Speaker 1: attached to California because it's all done through these you know,
Speaker 1: these special districts to get around the prop their team
Speaker 1: barrier and the barrier of the balanced budget country. But
Speaker 1: it doesn't mean it's not out there. It just you
Speaker 1: need to know where you look. Let's just talk a
Speaker 1: little bit more about you know, we're talking about these
Speaker 1: sort of like constraints in the law that states have.
Speaker 1: They have different ways of getting around them. Or even
Speaker 1: theoretically a state or a city could call a special
Speaker 1: session of the legislature and change the laws if they
Speaker 1: have If they have them in the law, that's up
Speaker 1: to them. What would be in the in your view,
Speaker 1: and maybe um ascanda could start with you, but others
Speaker 1: join in, what would be sort of the ideal instrument
Speaker 1: here for the FED, because you know, as you all
Speaker 1: of you pointed out, there's numerous different ones. There's water
Speaker 1: authorities and transit authorities, and so it's extremely complicated mosaic
Speaker 1: of different issuing authorities and states in times, what would
Speaker 1: be the ideal instrument for the FED to announce that
Speaker 1: it would be willing to buy either primarily or secondarily,
Speaker 1: which then the it could be left up to the
Speaker 1: states or cities themselves too for about how they can
Speaker 1: issue under their existing law. Yeah, so in the ideal state,
Speaker 1: the US state local government debt market looks a little
Speaker 1: bit more like Canada's, I would say, in the sense
Speaker 1: that Canada issues what are effectively um Canadian provinces issue
Speaker 1: effectively general obligation debt, right, so it's backed by the
Speaker 1: taxation authority and it's all pretty um uniform and standardized
Speaker 1: and actually the Canadian provincial debt market, well, I don't
Speaker 1: know how much is actually I've had a trouble finding
Speaker 1: a lot of written product on this, but actually it's
Speaker 1: a very deep market and it's actually pretty sophisticated market
Speaker 1: relative to call it the US um UNI debt market,
Speaker 1: which is very fragmented, and there's a big difference between
Speaker 1: the revenue back bonds and uh general obligation debt. So
Speaker 1: it would be ideal if there was a deep market.
Speaker 1: The absence of that probably means that what would be
Speaker 1: this sort of second best solution, I think, is sort
Speaker 1: of direct loans that the FED makes to UM probably
Speaker 1: states in large cities that are of investment grade UM,
Speaker 1: so you obviously do there's the FED has certain quality
Speaker 1: justifiable qualms about engaging too much credit risk, so at
Speaker 1: least keeping it to sort of the same parameters that
Speaker 1: kept for corporates. And then to some extent, if you
Speaker 1: if you just at every single state and local government
Speaker 1: entity that existed, it would obviously be a little bit
Speaker 1: hard to manage administratively. So I think it's just a
Speaker 1: starting point. Um, if state governments were willing to accept
Speaker 1: loans from the federal from the federal reserve. I think
Speaker 1: that's the kind of thing that should be encouraged in
Speaker 1: some ways and actually can This could be a chance
Speaker 1: to really catalyze some standardization and some ability for state
Speaker 1: governments to think a little bit more expansively about how
Speaker 1: to get the necessary financial flexibility in a crisis, which
Speaker 1: right now, um, they sorely lack. One of the problems
Speaker 1: with this idea that that a few people have pointed
Speaker 1: out is the notion of the FED actually coordinating this
Speaker 1: action with fifty state governments. How would you suggest they
Speaker 1: go about doing in that? So it is a regionalized
Speaker 1: federal reserve system to right there, twelve federal reserve banks,
Speaker 1: and they all have pretty close relationships across um their regions.
Speaker 1: I mean they they take a lot of pride in
Speaker 1: it um. So I don't actually think that I think
Speaker 1: fifty states is um compared to sort of like the
Speaker 1: scale of what they're they've been doing in other markets.
Speaker 1: It's not actually like insurmountable. You think about twelve federal
Speaker 1: reserve presidents, You've got um, twelve regional FED presidents that
Speaker 1: can help lead those efforts. They have a lot on
Speaker 1: their plate, obviously, but it's not the kind of thing
Speaker 1: that I think that's probably more manageable than trying to
Speaker 1: go about this through I mean, I think I think
Speaker 1: it's just a starting point that they obviously cann do
Speaker 1: secondary market purchases of municipal debt, and I hope they
Speaker 1: at least start with that. But I think as far
Speaker 1: as actually kind of giving state governments the appropriated fintange
Speaker 1: flexibility and working with state treasures, fifty state treasurers, twelve
Speaker 1: regional fed banks is not something I think that's actually
Speaker 1: a logistically challenging as opposed to trying to do it
Speaker 1: with every single city and county and township. That's probably
Speaker 1: too much. It's also it's also worth noting that a
Speaker 1: like large proportion of local government revenues are actually inter
Speaker 1: governmental transfers from the state level, and this is one
Speaker 1: of the first things that goes in a crisis. When
Speaker 1: states start to face a budget crunches, they cut their
Speaker 1: you know, offerings to local governments. And part of the
Speaker 1: reason for this is that local governments have a large
Speaker 1: part of their like own source revenue drawn from property tax,
Speaker 1: which is actually comparatively inflexible to the overall you know,
Speaker 1: sort of employment picture at a given time, because property
Speaker 1: tax assessments, you know, come every know, a couple of
Speaker 1: years or whatever, and so your problem is not that,
Speaker 1: you know, income goes down and receipts immediately go down.
Speaker 1: It's that income goes down and delinquency goes up a
Speaker 1: little bit in those situations. So there's a kind of
Speaker 1: you know, every man for themselves to these inter governmental
Speaker 1: transfers in a crisis um. And so if we backstop
Speaker 1: these fifty states, there's sort of an existing administrative framework
Speaker 1: for those fifty states to then in turn back stop
Speaker 1: their own sort of local governments. And even within the states,
Speaker 1: there's all the there's this perception that there's this jigsaw
Speaker 1: puzzle of special districts. But in a lot of states,
Speaker 1: as we've surveyed and looked at a lot of them,
Speaker 1: actually there is the fiction that all of these things
Speaker 1: are being coordinated through the Treasury Department, through the Treasuries
Speaker 1: or some kind of special body that coordinates the district
Speaker 1: and has all the districts and has all the information
Speaker 1: on them. So we've been talking a lot about moral
Speaker 1: hazard and perceptions of how this will work. And I
Speaker 1: guess one of the things I was wondering about is
Speaker 1: the muni market. Themuni bond market is kind of a
Speaker 1: special one. It comes with all these tax benefits, and
Speaker 1: I'm thinking of how to phrase this question, but I
Speaker 1: guess I guess I'm wondering about the moral hazard when
Speaker 1: it comes to bailing out investors or effectively bailing out
Speaker 1: investors in muni debt. Like these are people who probably
Speaker 1: do have a lot of assets who are probably investing
Speaker 1: in muni bonds because they're worried about taxes. Does that
Speaker 1: make this move more politically sensitive than it would be otherwise?
Speaker 1: I think the sort of the sort of h qualms
Speaker 1: about asset purchases and who they benefit. I think that
Speaker 1: means if it's a valid point to bring up in
Speaker 1: the sense that the people who own these assets and
Speaker 1: who will probably benefit from uh loosening financial conditions and
Speaker 1: more broadly tend to be on the wealthy end of
Speaker 1: the spectrum, I'm not sure it's necessarily disproportionate for um
Speaker 1: muni market. Obviously, there's a tax exemption within. If you're
Speaker 1: a California investor in California debt, I mean you have
Speaker 1: the tax exemption, full tax exemption there um as opposed
Speaker 1: to you can't. Actually is a very weird thing because
Speaker 1: it actually narrows the investor based in some ways, because
Speaker 1: if you're in New York investor in California debt, you
Speaker 1: don't really get any real benefit there. It's a tax exception.
Speaker 1: So UM it tends to lead to be certain narrow
Speaker 1: investor bases, and it's UM, I I appreciate the point,
Speaker 1: but also it's it's also one of these things that
Speaker 1: we're doing this in corporate bonds, We've done this in
Speaker 1: other asset classes. I'm not sure if you think about
Speaker 1: like who owns munies versus who owns most financial assets,
Speaker 1: I think that that skew tends to be the same.
Speaker 1: If anything, it's probably more likely to be skewed for
Speaker 1: asset classes that are U have a truly global investor
Speaker 1: investor base, as opposed to if you're buying Idaho bonds
Speaker 1: and you're an Idaho investor. There's at least some sort
Speaker 1: of these are pretty narrow investor bases itself. But yes,
Speaker 1: there is some distortion there to UM acknowledge, and the
Speaker 1: distortion goes both ways, right, Because one of the reasons
Speaker 1: it's not a great market is because most of the
Speaker 1: reason you buy municipal bonds is tax exemption. So you
Speaker 1: have very very liquid markets, you have very shallow markets,
Speaker 1: and these are the markets that since n have funded
Speaker 1: all infrastructure investment in this country. So it's I think
Speaker 1: it's less of a moral hazard problem than the underlying
Speaker 1: market structure not being very stable, and I do, and
Speaker 1: I think the advantage of moving this program along is
Speaker 1: to get some standardization and to get some thinking and
Speaker 1: information on how to fix these markets in the long run,
Speaker 1: if I could turn around the moral hazard point um
Speaker 1: as well, the fact that the overwhelming majority of this
Speaker 1: infrastructure is funded in these municipal bond markets is itself
Speaker 1: a kind of moral hazard question of the federal government
Speaker 1: displacing its responsibility to fund state level infrastructure projects onto
Speaker 1: these municipal bond markets by forcing states to create these
Speaker 1: off budget enterprises in order to do necessary investment. There
Speaker 1: is a good graph going around showing that basically net
Speaker 1: investment at the state level, sort of in fixed capital formation,
Speaker 1: has been you know, net net plus or minus, you know,
Speaker 1: zero point one five percent of zero. Since it's like
Speaker 1: really been kind of abandoned in that way. And so
Speaker 1: these moral hazard questions of oh, what if these local
Speaker 1: places spend too much money and then distribute that the
Speaker 1: cost to everybody else. In practice is actually inverted, where
Speaker 1: the the refusal to fund state infrastructure projects at the
Speaker 1: federal level, and also the progressive increase in unfunded mandates
Speaker 1: put by the federal level on the state level essentially
Speaker 1: create a moral hazard problem of the federal level, which
Speaker 1: does not need taxes in order to fund it spending
Speaker 1: essentially absorbing the tax basis of these state level governments.
Speaker 1: Before we wrap up, just real quickly and anyone can
Speaker 1: take this, what are the consequences economically if we were
Speaker 1: to see a sort of wave of austerity from state
Speaker 1: and local authorities on top of this that largely went unchecked.
Speaker 1: So we have something in the Carre's Act, there's some
Speaker 1: money going to stay locals, but maybe they'll do a
Speaker 1: little bit more. How bad could it compound the problem
Speaker 1: of recovering if there's not something sort of done imminently
Speaker 1: to to address this crisis. In terms of how long
Speaker 1: it takes us to get back to pre crisis level,
Speaker 1: we saw after two thousand eight that it took until
Speaker 1: for a fair number it states to recover trend growth
Speaker 1: and tax revenues. Uh, and if we've seen from other
Speaker 1: data that the immediate demand drop off has been so
Speaker 1: much steeper than it was in two thousand eight, and
Speaker 1: so much more tied to basically things that takes place
Speaker 1: in you know, physical space, you know, use of use
Speaker 1: of public services, use of retail, brick and mortar, use
Speaker 1: of all of these things that generate tax revenues. So
Speaker 1: I mean, just going from that baseline, I mean, it's
Speaker 1: it seems like a disaster if further relief is not forthcoming.
Speaker 1: All right, Well, uh, thanks to all three of you
Speaker 1: for joining us. Really appreciate all your perspective. Not something
Speaker 1: that we've discussed much on the podcast before. So Skanda,
Speaker 1: Alex and Yakov, thanks for joining outline. Thanks so much,
Speaker 1: thanks for having us. Yeah, thanks, thanks Tracy. I really
Speaker 1: liked that conversation. I really liked you know, all the
Speaker 1: allusions to the Eurozone crisis are like coming back to
Speaker 1: this crisis, except in reverse, because of course, that was
Speaker 1: essentially the problem in the Eurozone posts the Great Financial Crisis,
Speaker 1: which is that you had all these authorities, they didn't
Speaker 1: print their own money because none of them have their
Speaker 1: own central bank. They were all credit constrained, they're all
Speaker 1: forced into austerity, and it's like that's like, it's this
Speaker 1: weird US parallel we're facing, where this time the question
Speaker 1: is how much domestic US austerity will we see because
Speaker 1: none of these entities currently have access to a sort
Speaker 1: of either blame check funding from the central Bank or
Speaker 1: the ability to conduct their own countercyclical fiscal policy. Yeah.
Speaker 1: I'm also getting terrible target to flashbacks where everyone was
Speaker 1: sort of arguing about whether or not that liquidity support
Speaker 1: from the e c B amounted to a stealth bailout
Speaker 1: of certain Eurozone members. Uh. Those were fun times. But
Speaker 1: I do think this this idea of mixing fiscal policy
Speaker 1: um with monetary policy, or having a monetary policy authority
Speaker 1: step in to allow fiscal stimulus to happen through the states,
Speaker 1: I think that's really interesting and it's one that we've
Speaker 1: touched on before. I guess the stion is, you know,
Speaker 1: the Federal Reserve is this sort of unelected um body
Speaker 1: that has a very specific mandate. But it feels like
Speaker 1: in a situation like this, they're encroaching on a bunch
Speaker 1: of different areas, but people aren't necessarily worried about it
Speaker 1: in this particular circumstance, because what they're doing seems very
Speaker 1: very needed. It. I just wonder how far it's going
Speaker 1: to go and what the pushback is going to be,
Speaker 1: if there is any eventually. I also think it says
Speaker 1: something about sort of the US culture in US politics
Speaker 1: in general, that like, if if the Federal Reserve buys
Speaker 1: so called investment grade debt or backstops that market, like okay,
Speaker 1: we need to do that credit dislocations, etcetera. But if
Speaker 1: the Federal Reserve were they say like backstop or by
Speaker 1: the debt of New York State or California, something like, oh,
Speaker 1: you're bailing out the states, and we we we have
Speaker 1: this like weird thing where in our system we're actually uh.
Speaker 1: The sort of central view of many people who sort
Speaker 1: of talk about that stuff is that it's somehow more
Speaker 1: legitimate to back up, backstop banks and companies than it
Speaker 1: would be to backstop New York City or New York State,
Speaker 1: which is actually directly fighting this health h this health emergency. Yeah,
Speaker 1: as much as people complain about corporate bailouts, you can
Speaker 1: imagine it would be even worse for state bailouts. And
Speaker 1: again that's It's kind of weird because ultimately all the
Speaker 1: states are part of the United States of America, and
Speaker 1: yet we have these weird divisions. I guess that's the
Speaker 1: nature of the US political system. But it is definitely
Speaker 1: worth discussing and worth reminding people of in the context
Speaker 1: of what's going on in finance and markets and the
Speaker 1: economy right now. And I think people forget just how
Speaker 1: much much friction there is between these individual state level
Speaker 1: governments and the federal government at the moment. Yeah, because
Speaker 1: the way the US is set up, there's all kinds
Speaker 1: of sort of gaps there, and I do think that's
Speaker 1: really important. Like, look, we've had like this incredible crisis
Speaker 1: that pushed us from a very strong economy into sort
Speaker 1: of depression level economic activity for a while or in
Speaker 1: really just a matter of weeks, and even if we
Speaker 1: were to find a cure or a health solution in
Speaker 1: the next month or something, and of course no one
Speaker 1: really expects that. The asymmetry is such that as um,
Speaker 1: I forget who mentioned it, I think it was Alex
Speaker 1: pointed out it took until fourteen during the last crisis
Speaker 1: to return to sort of a trend state tax collection,
Speaker 1: so it could just be. It could be years of
Speaker 1: unnecessary austerity budget cuts, further economic pain simply as a
Speaker 1: result of what could you know, and hopefully will be
Speaker 1: a very like short real shock to the system, which
Speaker 1: makes it all the more urgent to come up with
Speaker 1: some mechanism to prevent that. Absolutely. Uh, time is of
Speaker 1: the essence here alright, speaking of time, shall we leave
Speaker 1: it there? Let's leave it there alright. This has been
Speaker 1: another episode of the All Thoughts podcast on Tracy Alloway.
Speaker 1: You can follow me on Twitter at Tracy Alloway and
Speaker 1: I'm Joe wi Isn't All. You can follow me on
Speaker 1: Twitter at the Stalwart, and you should follow our guests
Speaker 1: on Twitter. They are Sconda Amarnath of Employee America. He's
Speaker 1: at Irving Swisher on Twitter, Yaca Fagan of the Burgrowing
Speaker 1: Institute He's at Buddy Yakob and Alex Williams of the
Speaker 1: Levy Institute. He's at Tragic Bios on Twitter. And be
Speaker 1: sure to follow our producer on Twitter, Laura Carlson. She's
Speaker 1: at Laura M. Carlson. Follow the Bloomberg Head of Podcasts
Speaker 1: on Twitter, Francesca Levi at Francesca Today and check out
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Speaker 1: Thanks for listening to