I missed this when it actually took place last week. The State of Illinois has secured a reprieve from its fiscal crisis. From Truth in Accounting:
On April 9, amidst plunging economic conditions, the Federal Reserve announced a set of lending policy initiatives that included a new “Municipal Liquidity Facility†for state and local governments. For legal authority, the Fed cited the emergency lending provisions in section 13(3) of the Federal Reserve Act.
Normally, a central bank lends to banks, but emergency provisions have historically been used by the Fed to justify direct lending to “individuals, partnerships and corporations†in “unusual and exigent circumstances.†Section 13(3) is titled “Discounts for individuals, partnerships, and corporations,†raising questions whether the Municipal Liquidity Facility is actually authorized under Section 13(3).
The new facility is unprecedented. It is available to cities and counties meeting population requirements, and all 50 states. Smaller cities and counties may be supported by state borrowing through the facility. The lending facility is operated by the Federal Reserve Bank of New York. The facility may lend as much as $500 billion.
The State of Illinois became the first entity to use the facility, under a transaction that closed last Friday.
The balance of the post considers whether a) the Fed has exceeded its authority in extending a loan to Illinois (it has) and b) whether the Fed is being reckless in extending credit to Illinois (it is).
Note that securing a short term loan from the Federal Reserve doesn’t change the fiscal, political, or behavioral basis of Illinois’s problems. It is almost literally just kicking the can down the road.
Oh, well. The caliph may die, the donkey may die, or I may die.
I predicted the Federal Reserve would be bailing out Illinois.
But it brings into view the train at the end of the tunnel. How long can the Fed print?
The reason why the Fed can print and the Congress can borrow while the nation carries a trade deficit of half a trillion is the dollar’s reserve status based a foundation on the rule of law. i.e. those US debt sent overseas can be used to buy American assets, and those assets are safe from political turmoil or arbitrary expropriation. It is all based on trust.
Foreign observers are noting the political turmoil.
Lets pray the US will not face a Charles I recalling parliament or Louis XVI recalling estates-general moment anytime soon.
I’ve been warning about the limits of issuing credit for years. However, there are other reasons to want dollars than those you’ve mentioned, among them:
– other countries want to buy things whose prices are denominated in dollars, e.g. oil
– there isn’t a better alternative
Those are still both working in our favor.
Back in January; I would have whole heartedly agreed with the lack of alternatives.
The more things get heated here in the US; the more urgent the search for an alternative. Necessity is the mother of all inventions.
The next best alternative, the euro, is actually in worse shape than the dollar. The yuan isn’t covertible; I can only chuckle to think of the yen; the pound—are you kidding?
Can you say moral hazard?
There is the barbaric metal.
Since 13(3) was written with authority over individual, partnerships and corporations, the Fed is treating the State of Illinois as another corporation. In that case, the Fed may assert its authority consistent with past actions. When loans are made to banks, among the first items the Fed prohibits is exorbitant compensation. Does this mean that until the loan to Illinois is repaid, the Fed can exercise its authority and stop payment of pensions that are beyond all reason or sanity? Does the Fed have the capacity to force modification to an Illinois Constitution that assures a bankruptcy? As in so many other corporations, may the Fed force management into an austere balanced budget?
That is a good point, Lee. If Illinois is a corporation for the purposes of the Federal Reserve Act why not for the purposes of bankruptcy as well?