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Moral hazard is always a concern when fighting economic and financial crises. This time its imperiling federal aid to cash strapped states
Reformers aren’t keen on the Federal Reserve lending to prop up the financial markets, worried that traders who took risky bets will be made whole, causing even riskier bets next time.
The Bush and Obama administrations dithered and ultimately dropped the ball on meaningful aid to homeowners under water on their mortgages during the 2008 financial crisis, worried they would be criticized for helping homeowners who were not prudent with their spending.
And now aid to state government, the big weak spot in the U.S. economic outlook, is being held up by a long-standing Republican concern that assistance will help states who were not careful with their finances.
This long-running concern is set to come into focus as Congress turns to the next coronavirus relief bill.
For Democrats, assistance for state government is a must-have and vital for helping the public cope with the COVID-19 pandemic.
“There will not be a bill without state and local (aid),” said House Speaker Nancy Pelosi (D, Calif.) at a press conference Friday at the U.S. Capitol.
That stood in sharp contrast to comments by Senate Majority Leader Mitch McConnell (R, Ky.) who told conservative radio personality Hugh Hewitt he’d rather see states explore the option of declaring bankruptcy, if necessary.
“I would certainly be in favor of allowing states to use the bankruptcy route. It saves some cities. And there’s no good reason for it not to be available,” he said Wednesday.
McConnell’s comments continue to draw bipartisan rebuke from other lawmakers.
“Those remarks are repugnant and unAmerican,” said Rep. Gerry Connolly (D, Va.), adding that states implement federal policies.
“To say to them that their only alternative is to file for bankruptcy – which by the way, for most of them, would be illegal – is the most callous, social Darwinism I think I’ve ever heard in my time in public life.”
States are staring at a steep drop in revenues.
The National Association of State Budget Officers estimated many states expect a drop of more than 20 percent in sales tax revenues for April as the nationwide lockdowns restrict consumer spending. Sales taxes are the second largest source of receipts for states, after income taxes, which are also expected to take a big hit as employers lay off workers.
“Additional direct aid to the states, with maximum flexibility to cover revenue loss, will ensure funding for key services including public safety, health systems, infrastructure, and education, while also enabling states to move quickly in re-opening the economy,” the group said in a letter to lawmakers.
Republicans worry giving states aid without strings attached will mean spendthrift states will put off overhauling big ticket items, like unfunded pension systems.
“There’s not going to be any desire on the Republican side to bail out state pensions by borrowing money from future generations,” McConnell said.
Read:Next coronavirus package might not come until June
Rep. Tom Cole (R, Okla.), the top Republican on the House Rules Committee, said some restrictions would likely be needed to get the GOP on board. “I think there’s a lot of concern on our side that it won’t just be for coronavirus stuff. It would be for faulty pensions plans and stuff like that. I think if it happens, it’s going to take parameters about what the spending is for,” he said.
Rohit Kumar, leader of accounting giant PWC’s tax policy services and a former top adviser to McConnell, told Bloomberg Radio finding a compromise would take time.
“That is not something you do in a week. That will require some negotiation.”
Concern over some states’ fiscal positions before the coronavirus struck is not limited to Republicans.
Rep. Jim Cooper (D, Tenn.), who has a reputation as one of the House’s most ardent budget deficit hawks, said, “Some states have been more responsible than others in managing their finances and hardworking thrifty states should not be penalized for their good efforts. Likewise, we shouldn’t reward states that haven’t performed as well.”
If state aid delays the next coronavirus bill or is left out entirely, there is another potential lifeline for states, but it could be controversial: the Federal Reserve.
The central bank has taken a small step into helping state and local communities, earlier this month setting up a Municipal Liquidity Facility (MLF). The Fed facility will buy an initial amount of $35 billion in debt issued by states, the District of Columbia, cities with more than a million residents and counties with more than two million residents.
The Fed said it would limit debt it buys from state and local governments to 20% of the 2017 revenue generated by individual issuers and their utilities, placing a self-imposed constraint on the program.
Cole said if Republicans and Democrats can’t reach a compromise and the states are left without aid, it may mean the Fed is forced to step in.
“That would be unknown territory,” he said.
Cooper said he wanted to see Congress act. The Fed “stretched their mandate almost beyond recognition in 2008. Now it’s stretched even farther. No one knows the limit of that tether, but it’s not unlimited,” Cooper said. “This is actually work the government should be doing, not monetary authorities.”
U.S. equity benchmarks were lower this week. The Dow Jones Industrial Average DJIA, +1.10% was down 467 points or 1.9% this week to close at 23,775.
