The Impact of Covid-19 Related Policy Responses on Municipal Debt Markets

Abstract

Municipal (muni) bonds are an important source of funding for state and local governments. During the Covid-19 pandemic, muni debt markets became severely distressed. In response, the Federal Reserve established the Municipal Liquidity Facility (MLF). Meanwhile, Congress enacted extensive fiscal measures that included direct aid to cities and states. To understand whether and how these policies worked, we employ a state-level regression model to estimate the relative efficacy of monetary and fiscal policy interventions for the term structure of muni-Treasury yield spreads. We find that fiscal and monetary policy together reduced those spreads by as much as 245 basis points. Fiscal policy contributed twice as much as monetary policy to the notable decline in shorter-term muni-Treasury spreads. At longer maturities, the contribution of fiscal policy was at least three times as large as that of monetary policy, suggesting that it addressed fundamental credit concerns.

Limits of Disclosure Regulation in the Municipal Bond Market

“…Finally, our paper is also related to the recent literature studying the impact of the Covid crisis on the municipal bond market. This literature has found that government transfers and guarantees of liquidity in the municipal bond market during the Covid crisis such as the MLF has led to lower financing costs for issuers in the primary market and decreased yields in the secondary market (see, Bernhardt et al (2021), Fritsch et al (2021, Li and Lu (2020), Bordo andDuca (2021), Haughwout et al (2021), Bi and Marsh (2020)). 6 We complement these studies by showing that disclosure significantly mitigates the effect of the pandemic on municipal bond yields in the secondary market.…”