United States: Municipal Liquidity Facility

In March 2020, the COVID-19 pandemic caused severe financial stress for state and local municipalities. Municipalities' public health responses led to material increases in expenditures. At the same time, many municipalities faced revenue delays and declines due to extended tax deadlines and disruptions in taxable economic activity. Institutional investors also put heavy selling pressure on municipal bonds. In response to stresses in the municipal financing market, the Federal Reserve invoked its Section 13(3) emergency lending authority and created the Municipal Liquidity Facility (MLF). The Fed created the facility to backstop municipal entities' access to capital markets to help them manage cash flow disruptions and higher borrowing needs. The MLF was available to purchase up to $500 billion of notes directly from large municipal issuers. These Fed credit extensions came with maturities up to three years and at fixed, rating-dependent spreads above the comparable overnight indexed swap rates. The Treasury secretary committed $35 billion allocated by the Coronavirus Aid, Relief, and Economic Security (CARES) Act as an equity layer for the MLF; this provided the Fed with first-loss protection. The Fed received extensive feedback from legislators and municipalities, and it eased the MLF's eligibility criteria, maturity, and interest rates between April and August 2020. The facility ultimately had low utilization compared to its capacity, purchasing just $6.6 billion of bonds across four issues. However, the Fed argues that the announcement of the facility as a market backstop improved market conditions. Liquidity and credit conditions in the municipal market staged a rapid recovery after the announcement of the MLF; in 2020 as a whole, municipal issuance volume reached a record $474 billion. However, municipal spreads remained elevated throughout 2020 relative to pre-pandemic spreads, especially among lower-rated issues.