No More State Bailouts, States Have Means According To Bernake

In testimony on Friday before the Senate Budget Committee, Federal Reserve, Chairman Ben S. Bernanke, was asked specifically about providing assistance to state and local governments facing budget deficits and high borrowing costs. His short answer: It’s not going to happen. Concerns have been mounting recently of a potential crisis in the municipal bonds market because states are struggling to pay off debt thus raising costs for municipal borrowers.

The Law Won’t Allow Intervention

The law concerning this right now says that the Fed only has legal authority to buy muni debt with maturities of six months or less that is directly backed by tax or other assured revenue, which makes up less than 2% of the overall market. The Dodd-Frank financial-regulation law enacted last year further tied the Fed’s hands, Mr. Bernanke noted, by barring the central bank from lending to insolvent borrowers or pursuing bailouts of individual borrowers.

None Offered Before, And No More To Come

When a severe sell-off hit the municipal bond market in November, sending bond prices tumbling and yields surging, Wall Street was buzzing with the idea that the Fed would step in to support the market by buying muni bonds for its own balance sheet. But at the time there were no hints from the Fed that it might offer a lifeline to the muni market, and Bernanke offered none on Friday.

No Worries…Yet

When asked about the recent Meredith Whitney projections that were aired in CBS’s 60 minutes, he conceded that many state and local governments are under fiscal stress, but said: “We don’t at this point see anything of that magnitude happening.” Then he asserted that state and local governments have the tools to deal with their fiscal problems and debt, and the municipal bond market “currently seems to be functioning reasonably well,” he said.

No States Defaulting As He Sees It

He was asked if the Fed has looked at the possibility that states will default on their muni bonds, particularly after they stop receiving stimulus funds in June. “No question, state and local governments are under a lot of pressure,” Bernanke responded. Bernanke said, “The bottom line is that there is a lot of liquidity and issuance in the muni bond market and it seems to be doing okay. But clearly there’s a lot of both near-term and longer-term pressure on these governments and it’s going to be something that’s not going to be going away in the near term.”