As Federal Aid Stalled, State And Local Governments Issued Bonds To Pay Current Bills
State and local governments have been turning to a potentially dicey borrowing tactic to support their budgets as the coronavirus recession wears on without direct, flexible financial aid from Congress.
Some governments are taking on debt to help pay for their operating expenses, a practice known as deficit financing and one that raises red flags. It’s akin to paying your rent on your credit card and letting the interest pile up: you get through the immediate future but ultimately have larger payments down the road.
Between August and mid-December of 2020, at least one-quarter of large bond issuances in the municipal market involved some form of deficit financing, according to an analysis by Municipal Market Analytics (MMA). The firm analyzed 442 municipal bond issuances that totaled at least $100 million.
MMA’s Matt Fabian and Lisa Washburn added that their tally was conservative and that as many as half of those 442 issuances may have involved deficit financing because the ultimate use of the money wasn’t always clear.
“These are not typical uses of the municipal bond market, where an overwhelming majority of financing is for long-term infrastructure projects,” they told the Pew Charitable Trusts. “But last year, with state and local governments seeking as much as possible to avoid cutting spending, raising taxes, or postponing pension payments, they shifted their emphasis to short-term and temporary solutions. As the pandemic continued and federal stimulus money dried up, they increasingly took on debt for budgetary help.”
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Fabian and Washburn found that governments used the municipal bond market to reduce or postpone annual expenses, raise operating capital, and restructure otherwise damaged finances. The primary form of deficit financing were what is called “scoop and toss” refinancings: To free up cash-on-hand, governments issue new bonds to retire old ones — and then delay a significant portion of those new debt service payments.
Among those governments employing the practice is Chicago, which in October said it planned to use scoop and toss borrowing to take out an additional $1.7 billion in debt to refinance existing city debt.
MMA also found evidence of “indirect deficit refinancing,” such as using money from bonds to pay for projects that previously were paid for with cash.
Borrowing money to pay for operating expenses doesn’t fix the fundamental budgetary imbalance and is why any kind of deficit financing tends to sound alarm bells. It’s also very rarely used by states to balance budgets. (The federal government, however, regularly borrows money to cover spending.)
But borrowing money to plug a budget hole doesn’t automatically spell trouble for a government. No governments have been downgraded yet because of the practice. And in times of extreme crisis, policymakers are expected to use all the tools available to weather the storm.
“Any response to fiscal emergencies such as those caused by the coronavirus comes with challenges and limitations,” Fabian and Washburn said. “In this case, borrowing became one part of a package of budget and policy responses, one that may have allowed governments to avoid, at least for the time being, other harsh measures—such as raising taxes or cutting services.”
Revenue shortfalls across, state, local and county governments are expected to collectively total around $1 trillion over the next few years. As Congress stalled last summer on a second major stimulus package and budget deficits mounted, there were warning signs that governments could resort to borrowing money to get by.
The federal government did step in in other ways, namely the Federal Reserve’s emergency borrowing program. The Municipal Liquidity Facility offered low-interest loans but only Illinois (the lowest-rated state) and New York’s MTA ended up using the program. That’s because low interest rates in the $3.9 trillion municipal-bond market kept the program attractive only to the most fiscally-challenged. The Trump administration directed the Fed to end the program on Dec. 31.
Under a new administration, some hope that state and local governments will get the direct and flexible aid they’ve been asking for since last summer. President Biden has called the $900 billion relief package passed in December a “down payment” on future federal stimulus legislation.
Biden has also supported direct aid for state and local governments. The December relief package originally included $160 billion in flexible budget aid for governments, but it was removed as part of a compromise.
Under the CARES Act passed in March 2020, governments got billions in aid but it could only be used for pandemic-related spending. While that money has been critical, governments have said that plummeting revenues continue to create long-term budget pressure.
Fabian and Washburn warn that deficit financing also results in prolonged budget pressure and it’s not likely going away just yet.
“It’s too early to say for sure, but there’s reason to suppose that debt incurred now is unlikely to disappear from government balance sheets for years to come,” they said. “What’s more, because state and local financial conditions this year are likely to be closer to the second half of last year than to 2019, we see no reason not to expect similar borrowing this year.”