October 25, 2017 at 5:00 am ET
President Donald Trump and congressional Democrats don’t agree on very much these days, but they do share the belief that it is imperative we improve the country’s aging infrastructure.
Trump has characterized it as “crumbling” and in need of replacement. Sen. Chuck Schumer (D-N.Y.) has said Senate Democrats support “repairing and rebuilding our nation’s crumbling infrastructure.” Across the country, bridges collapse, roads disintegrate and water mains rupture. These are more than mere inconveniences; they are threats to the very lives of millions of Americans.
Despite this bipartisan agreement, however, funding infrastructure repair faces two major obstacles. The first is political: With the federal government over $20 trillion in debt, it’s unlikely that deficit hawks will agree to finance the $1 trillion in federal government spending that Trump wants to improve our infrastructure.
Even if that’s the case, however, state and local governments could finance infrastructure repair by issuing bonds. This approach has the advantage of ensuring that local communities have more of a say in what repairs are made, rather than allowing federal agencies to control projects funded by federal tax dollars. But that brings us to the second problem, which is regulatory: Federal regulations have made it very difficult for financial institutions to finance infrastructure spending with state and local bonds.
This is a recent development. Jim McIntire, the former treasurer of Washington state and former president of the National Association of State Treasurers, has estimated that three-quarters of infrastructure in this country is financed by state and local governments, and almost all of that is financed with municipal bonds. Traditionally, banks have constituted a large part of the market for such bonds, holding as much as 25 percent of municipal securities outstanding.
But recent federal regulations reduce the appetite that banks would have for such municipal bonds. Specifically, Federal Reserve Regulation WW and similar regulations adopted by the Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency impose “liquidity risk measurement standards” on larger banks.
The regulations, intended to strengthen the liquidity positions of large banks, require those banks to hold large amounts of “high-quality liquid assets” that can be converted easily and quickly into cash. These “high-quality liquid assets” are required to be held in an amount at least equal to the bank’s net projected cash outflows during a 30-day stress period.
The problem for municipal bond issuers and infrastructure financing is that municipal bonds generally do not qualify as “high-quality liquid assets” because, in the view of federal bank regulators, municipal bond markets are not liquid enough to enable banks to convert them into cash easily and quickly.
To their credit, federal bank regulators recognized problems with their initial rules and revised them to give liquidity credit to half of the fair value of certain municipal bonds, making them a little more attractive to banks than they were before the amendment. But nonetheless, the bonds are still unlikely to be as attractive investments as they were before adoption of Regulation WW. That ultimately means fewer banks buying municipal bonds and, thus, less money available to finance infrastructure improvement and raises the specter of more federal control of these improvements.
To make municipal bonds an attractive investment for banks, the Federal Reserve, FDIC and OCC should consider withdrawing their regulations. Such a decision would not only enable more infrastructure spending financed by municipal bonds, it would also ensure more state and local control of these projects and less influence by officials in Washington.
Julius “Jerry” Loeser is a former chief regulatory and compliance counsel for Comerica Bank and is an expert contributing to the Federalist Society’s Regulatory Transparency Project.
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