Private-public efforts helped to avoid fear city scenarios for municipalities
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Coronavirus has devastated the finances of many households and companies. But those are far from the only entities affected. Municipalities and public entities across the U.S. are facing the same budget shortfalls and potential difficulties accessing credit. State and city governments are facing rising unemployment claims, and falling tax revenues based on income and sales. The rising automatic spending and decline of revenue put public entities at all levels in financial distress. NY State, for example, is facing a $9bn to $15bn budget shortfall. And as early as April 7th, NYC Mayor De Blasio has already made plans to cut budgets on education, social services, transportation, etc for $1.3bn.
We will explore below:
1, the unique challenges facing NY State
2, what has the federal government done to help
3, measures the federal government took in 2008 to help state and local governments
1, the unique challenges facing NY State
New York has been an epicenter of the pandemic and has been one of the earlier states to issue a stay-at-home order. The budget shortfall due to the length of the shut-in could be large. Cuomo has estimated the loss in revenue to be $9bn to $15bn this year.
New York state also relies heavily on personal income tax, sales tax, and taxes from the financial industry. Personal income tax and sales tax account for 39% of total revenue, which would likely be heavily impacted. The financial industry accounts for 17% of total revenue. While Wall Street banks have seen a rise in trading profit due to the increased volatility, they have also seen loan losses due to the deterioration in the economy. The net effect on tax collected is hard to gauge at this point.
The tax filing deadline for the state has been postponed to July 15th, the same as the federal filing deadline. It could delay any tax collection and budget estimation as a result, making liquidity a bigger concern.
Currently, New York State is expecting $8bn in direct federal aid, which would still leave the state $1–7bn short. The State currently has a ~$6.5bn deficit that it was looking to close before the pandemic.
The New York State is still an AA+ rated entity (the State general obligation credit rating). Although potential downgrade is possible as the budget possible or even likely given the projections of the state budget.
Absent of more federal aids, the state would have to cut budgets and spending to make up for the $9–15bn shortfall.
2, what has the federal government done to help
In the CARES Act, there is $150bn aids for states and local government, of which NY State is expected to receive $8bn. The democrats have been pushing for more aids for state and local governments and have made it a contentious point in the follow-on stimulus bill for small businesses. It is uncertain if or when more stimulus for state and local government will come next.
The Federal Reserve has also started to buy municipal bonds. This will prevent a credit seize of the municipal bond market and provide confidence to investors. But in and of itself, it will not likely provide much direct help to state and local government. The Federal Reserve will be buying already issued municipal bonds in the secondary market, rather than from primary issuance directly from the states. Granted a calmer municipal bond market would help stabilize primary issuance as well, the market has seen a 45% drop in primary issuance volume as most state and local governments are waiting for more clarity on the federal aid.
3, measures the federal government took in 2008 to help state and local governments
After the financial crisis of 2008, many state and local governments faced similar budgetary challenges where taxation fell and welfare spend soared. While there were cities that filed for bankruptcy during that time period (Jefferson county in Alabama and Detroit Michigan), the federal government put in a public-private joint effort in helping municipalities access the credit market and avoid defaults.
The program created is called the Build America Bond program. The program lowers the borrowing costs for state and local governments by providing a 35% direct payment for the interest component to the issuer from the federal government. This not only reduced the cost of raising debt for the state and local government, but also shared the credit risk with private investors stretching the federal dollars. Private investors would have the confidence that the federal government would help the state pay 35% of the interest and thus have a lower possibility of missed payment at the state and local level.
The program is also only available for new capital projects as opposed to refinancing issuances, hence the name Build America Bond. From February 2009 (when the program started) to December 2010 (when the program ended), there were $181bn bonds issued. If you do the math, the federal government only paid $63bn while allowing the private sector to fund the rest. According to the Treasury, the savings to the state and local government is estimated to be 1.12% over 30 years, which translates into more than $2bn dollars savings of borrowing cost.
This program has helped many state and local government to access the capital market, maintain the operating budget, and avoid severe austerity that could be counter-productive to recovery. More importantly, it is a shared risk and joint effort between the federal government and the private sector, making less of a toll on the federal budget. This has proven to be an important step in the aftermath of 2008 and should certainly be considered for Covid-19 recovery as well.
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