The Municipal Liquidity Facility (MLF) is a Federal Reserve program to buy up to $500 billion in debt from state and local governments that have suffered revenue declines as a result of the COVID-19 pandemic. Under the program, the Fed will buy short-term municipal notes from the states and the District of Columbia, certain city and county governments, and multi-state entities.

In addition, the Fed will monitor liquidity and credit conditions in the primary and secondary markets for municipal securities to decide whether it should take additional action.

Because of Coronavirus-related shutdowns, state and local tax revenue has plummeted. Sales taxes have fallen because people are purchasing fewer goods. Income taxes have dropped amid rising unemployment. To help make up the shortfall, the Fed's program will purchase municipal notes, allowing state and local governments to continue functioning through the crisis.

Key Takeaways

  • The Coronavirus pandemic has caused a sharp drop in state and local government tax revenue.
  • The Municipal Liquidity Facility is a Federal Reserve initiative to extend emergency funding to these governments.
  • The Fed will purchase up to $500 billion of municipal notes.

Details on the Municipal Liquidity Facility

The Municipal Liquidity Facility will make direct purchases of short-term notes issued by the 50 states and the District of Columbia. The Fed will also buy the notes of county governments with a population greater than 500,000 and city governments with a population greater than 250,000. The Fed had initially set population requirements at one million residents for cities and two million residents for counties, but lowered those thresholds on April 27, 2020. It also added the notes of multi-state entities (compacts between states) to the program. 

The Fed on June 5, 2020, modified terms once again to give cities and counties in less populous states a chance to qualify. Governors of certain states could designate their most populous city or country (or both, if they qualified) to participate in the program. In addition, the Fed widened the program so each state could designate two "revenue bond issuers," such as a utility or airport, to be eligible.

The Municipal Liquidity Facility is a special purpose vehicle (SPV). The U.S. Department of the Treasury will provide $35 billion in initial equity from the Exchange Stabalization Fund (ESF), as appropriated under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The remaining funding comes from the 12 regional Federal Reserve Banks.

The municipal debt instruments eligible for purchase include tax anticipation notes (TANs), revenue anticipation notes (RANs) and bond anticipation notes (BANs), and other similar notes. Eligible debt securities must have terms to maturity of no more than 36 months from the date of issuance.

A given state, county or city may have multiple entities, authorities or instrumentalities that issue debt on its behalf. The facility will limit itself to purchasing notes issued by only one issuer per state, county or city.

The facility also will limit purchases of notes from a given state, county or city to an amount equal to 20% of its 2017 fiscal year general revenue. However, states may apply for exceptions under which the facility will buy notes in excess of these limits. The same 20% cap applies to multi-state entities and revenue bond issuers, based on their 2019 fiscal year gross revenue.

Eligible issuers must pay an origination fee of 10 basis points on the principal amount of notes purchased by the facility. This fee may be deducted from the proceeds of the note issue. Notes purchased by the facility may be called by the issuer at par any time before maturity. On August 11, 2020, the Fed lowered the interest rate spread on tax-exempt notes by 50 basis points. The difference in rates between taxable and tax -exempt notes was also lowered.

Unless extended by the Fed and the U.S. Treasury, the facility will cease buying notes after Dec. 31, 2020. The Fed will continue to fund the facility until its assets mature or are sold.