Commentary on Political Economy

Thursday 17 December 2020



Hijacking the Fed to Bail Out States

Democrats are blocking Covid relief to keep 13(3) pandemic lending alive.

The U.S. Federal Reserve in Washington, D.C. PHOTO: LIU JIE/ZUMA PRESS
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The Covid relief talks drag on in Congress, with the parties more or less agreeing to spend $900 billion more over a mere three months. But they’re still fighting over the details, and a major obstacle is the Democratic desire to use the Federal Reserve next year to channel tens of billions of dollars or more to state and local governments.

The fight behind the scenes concerns the money and authority for the Fed’s 13(3) pandemic lending facilities. Senate Republicans, led by Pennsylvania’s Pat Toomey, want to repurpose some $429 billion in Cares Act money to finance roughly half of the new spending. The Fed made only $25 billion in loans and other commitments because most businesses and municipalities could borrow more cheaply in the private market.

Opinion: Potomac Watch

Fed Chairman Jerome Powell has agreed to return the unused funds to Treasury at Secretary Steven Mnuchin’s request. Though the Cares Act clearly called for the programs to end on Dec. 31, Democrats insist that the Biden Treasury could revive the programs and renew lending. That’s why Mr. Toomey also wants the bill to include language that leaves no doubt that the programs end on Dec. 31. The Biden Treasury would then need a new appropriation from Congress to revive the programs.

That Democrats are opposing the Toomey language gives away that their plan is to use the Fed to go around Congress if they don’t control the Senate next year. They’re afraid a GOP Senate won’t agree to another spending blowout to rescue profligate states like Illinois and New Jersey. They want to use the Fed’s municipal and state lending facility, which was stood up this year at the height of the pandemic and market disruption, as the bailout vehicle.


Even if the $429 billion that was turned over to Treasury is earmarked for other Covid relief, the Fed still retains some $35 billion to $40 billion as a backstop for its special pandemic facilities. That could be leveraged as much as 10 times to lend to states and cities at terms the Biden Treasury and Fed would set. That’s all the more reason for Republicans to hold firm on Mr. Toomey’s language ending the programs.

The financial markets are in good shape, unlike in March and April. Well-managed states are finding ways to navigate through the pandemic, and state revenues haven’t fallen nearly as much as feared. The draft $900 billion bill also includes tens of billions in aid for states earmarked for hospitals, vaccine distribution, protective equipment, child care, education, broadband, food stamps, public transit and more.

All of this is a matter for fiscal policy determined by Congress. Yet Democrats want to use the Fed as a second fiscal spigot that they can turn on at Treasury and Fed discretion. This isn’t the proper role for the Fed, especially when the financial emergency has passed. Illinois and New York’s Metropolitan Transportation Authority are the only two public entities that have borrowed from the Fed.

But if Treasury squeezes the Fed to offer conciliatory terms, or essentially free money, many others will line up. Given the politics of these states and cities, and their inability to reform anything in government, the Fed could end up taking major losses on those loans. Taxpayers would be the losers of this backdoor bailout.

Democrats are getting much of what they want in the $900 billion, which amounts to $300 billion a month. They’ll have another chance to spend more next year when they’ll control the House, the White House and perhaps the Senate.

This is all the more reason for Republicans to insist on the Toomey language as a dealbreaker in the Covid relief bill. If Democrats want to bail out public unions in progressive states, they ought to do it honestly through Congress. Leave the Fed out of it.

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