02.16.2017 2

Stopping the Fed’s muni bond bailout before it ever happens

By Natalia Castro

State and local governments have not been fiscally responsible, and with a federal government bailout ready at any time they have not had to be. However, as the growing pension crisis looms, U.S. Rep. Brian Babin (R-Texas) has introduced legislation to prevent the Federal Reserve from bailing out these reckless states and increasing accountability across the board.

The size of the municipal bond market alone is $3.8 trillion. Meanwhile state and local pensions could be underfunded anywhere between $1.5 trillion and $5 trillion based on economic estimates.

Currently, under Section 14(2)(b)(1) of the Federal Reserve Act the Fed can purchase municipal bonds from state and local governments for periods of 6 months. If a state is unable to make payments to state pensions for example, this would allow the Fed to essentially take the debt from the state governments and bail them out of their situation.

So far, such a bailout has not been necessary. Still, the backstop allows states to remain fiscally inefficient rather than renegotiate the deals created. For example, when a state makes outrageous promises to workers in the form of defined benefit plans and cannot deliver, they may be hoping the Federal Reserve will simply provide the funds.

Representative Babin’s legislation solves this problem and stresses culpability. The State and Local Pensions Accountability and Security Act would prevent the Federal Reserve from providing “any loan, grant, or other form of financial assistance to a pension plan established or maintained by the government of any State or political subdivision…or to the government of any State or political unless such government, agency, or instrumentality certifies that the financial assistance will not be used, directly or indirectly, to fund such a pension plan.”

This would stop states from ever using the Fed as essentially a printing press to make up for bad policy, a practice which will become more relevant than ever as pension programs begin to fail at the municipal level.

Forbes.com contributor William Baldwin reported in Jan. 2016 that states across the country are increasingly unable to cover the costs of defined benefit plans. States such as Illinois, Alaska, California, and New Jersey all stand at substantial risk for default because the public employee pension plans they promised are simply too great to be sustainable in the system.

Also pressing on the system is slower economic growth and lower revenues to state and local government coffers.

If the burden of these failures were transferred to the Federal Reserve, they’ll get a free pass—and create a horrible precedent where the federal government would have to guarantee all government pensions for all time. Why would any state and local governments ever get their finances together? Section 14(2)(b)(1) of the Federal Reserve Act is a loophole that must be called.

Americans for Limited Government President Rick Manning explained a more practical solution to the pension crisis in his latest press release: “If states and cities cannot meet their pension obligations particularly in defined benefit plans, they need to renegotiate the commitments that have been made so they can be sustained over the long term, not turn to the Fed for bailouts. This is a critical fix that will incentivize states and cities to get their fiscal houses in order and warrants immediate consideration and passage in the House.”

In his own statemen, Babin cited the necessity of removing the federal bailout as an option for states. Babin explained, “Passage of our legislation will send a strong message to these state, municipal and local governments that they must get their own fiscal house in order by making the tough decisions to put these systems on sound footing.”

Ultimately, pensions are a state’s responsibility and the federal government cannot continue to enable states to make fiscally careless policy decision in the hopes of federal intervention. Babin’s legislation will force states to be accountable for their fiscal policy and should be met with serious consideration — and passage — in the House.

Natalia Castro is a contributing editor at Americans for Limited Government.

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