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Do Municipalities Need a Lender of Last Resort? Evaluating the Federal Reserve’s Pandemic-Era Municipal Lending Program

By Arpan Patel

In March 2020, the COVID-19 pandemic pushed the $4 trillion American municipal debt market—a critical source of funding for state and local governments—to the brink of collapse. On March 27, 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security Act, which in part empowered the Board of Governors of the Federal Reserve and the Department of the Treasury to establish a Municipal Liquidity Facility to “help state and local governments better manage cash flow pressures in order to continue to serve households and businesses in their communities.” Although the Federal Reserve authorized the Municipal Liquidity Facility to lend up to $500 billion to municipalities, only two borrowers, who drew on 1.27% of the total capacity, tapped the facility. The debates that sprang up around the Municipal Liquidity Facility demonstrate that scholars have yet to grapple with the institutional, legal, and historical constraints of Federal Reserve support for state and local governments.

This Note addresses that gap. It begins by situating the Municipal Liquidity Facility within the history of the Federal Reserve’s monetization of municipal bonds. The Note goes on to evaluate Congress’ legislative mandate for the Municipal Liquidity Facility and the operational, political, and legal dynamics of the program. Finally, based on the institutional history, legal authority, and politics of the Federal Reserve, this Note examines policy proposals to reform the Federal Reserve’s role for supporting municipalities during crises. Ultimately, this Note attempts to place the pandemic-era policy experiment in historical context, and then draw out lessons to help answer a critical question for policy makers: when municipal governments face financing crises, what is the proper role for the Federal Reserve?

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