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Bernanke and GOP tell state and local governments: Don't ask for help

January 9, 2011 |  3:41 pm

If financially struggling states and municipalities were still thinking they might get some direct help from the Federal Reserve, Chairman Ben S. Bernanke pretty much quashed that idea last week.

In testimony on Friday before the Senate Budget Committee, Bernanke was asked specifically about providing assistance to state and local governments facing budget deficits and high borrowing costs.

His answer: It's not going to happen.

From the Wall Street Journal:

Federal Reserve Chairman Ben Bernanke on Friday ruled out a central bank bailout of state and local governments strapped with big municipal debt burdens, saying the Fed had limited legal authority to help and little will to use that authority.

"We have no expectation or intention to get involved in state and local finance," Mr. Bernanke said in testimony before the Senate Budget Committee. The states, he said later, "should not expect loans from the Fed."

The central bank has provided trillions of dollars in aid to the financial system since 2007 in the form of purchases of Treasury bonds and mortgage-backed securities and in direct loans to banks and other financial institutions (such as insurance giant AIG).

Benb 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.

Now, it's easy to make the case that Bernanke, in his testimony, was simply trying to push state and local governments to solve their own problems, and that the Fed could yet try to fashion some kind of bailout if the muni market were threatened with collapse.

But the Fed chief also knows what he's up against in Congress with the new GOP majority in the House. Many Republicans have made clear that they're adamantly opposed to any more bailouts.

From an interview that CNBC's Larry Kudlow did on Friday with Sens. Jeff Sessions (R-Ala.) and John Cornyn (R-Texas):

KUDLOW: I want to come back to the budget battle in one second, but just a last one on Bernanke and the hearing this morning. The Fed had said basically the Federal Reserve would not bail out states if they got into more trouble and threatened bankruptcy. What's your feeling? Did you talk -- did you engage him on that point? Is that going to be a hard and fast rule, no federal bailouts of states?

Sen. SESSIONS: Senator Cornyn and I raised it, and I followed up with it and got a pretty firm commitment that they had no intention of doing that. And he indicated they have very limited legal powers to do so, only in very short-term loans. I think that was a message to every governor and every state legislature that the federal government is not here to bail them out and they've got to maintain their own credit rating, they're sovereign states and they cannot continue the reckless spending that some of these big states are doing. My people in Alabama that run a frugal government don't think they should be paying to bail out reckless states like California or Illinois. And you see New Jersey, Governor Christie marvelously bringing his state under control. We need to see that from some of these other states.

KUDLOW: Senator, will that be Republican policy, not just for the Federal Reserve, but regarding federal spending? Will Republicans oppose any bailouts of states or localities?

Sen. SESSIONS: I'm confident that they will. When you say any, I don't -- I don't know exact -- what could occur, but I don't think that this federal government should be bailing out states, and I do believe that they need to recognize the crisis they're in and start bringing it in under control like New Jersey has. And if so, we won't have a default crisis.

Reuters blogger James Pethokoukis has gotten some mileage out of his theory that the GOP wants to make sure that the most fiscally troubled states (including California) are driven to the edge, or over it, as a way to break public employee unions by forcing renegotiation of pension and healthcare benefits.

Although local governments can file for bankruptcy protection, there is no allowance under federal law for states to do so. But Congress could change the law to give states the right to file for bankruptcy reorganization, an idea championed by University of Pennsylvania Law Professor David Skeel in an article he wrote for the Weekly Standard in November.

In the near term none of this will be helpful for the municipal bond market, which is still reeling from the November and December sell-off that hit all bonds but munis in particular. Investors pulled an additional $2.83 billion from municipal bond mutual funds in the week ended Dec. 29, though the pace of withdrawals slowed from the prior two weeks.

Tax-free muni bond yields have come down modestly from their December peaks but are still well above their lows of last fall -- though they're also still far below their peaks reached during the 2008 financial-system meltdown.

For a chart showing the average yield on a Bond Buyer index of 40 long-term muni bonds nationwide, go here.

-- Tom Petruno

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 Photo: Fed Chairman Ben S. Bernanke. Credit: Karen Bleier / AFP/Getty Images

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