House passes Messer-Maloney bill to encourage municipal bond investments by addressing regulatory misstep
WASHINGTON – The House of Representatives today passed legislation (H.R. 2209) authored by Reps. Luke Messer (R-IN) and Carolyn B. Maloney (D-NY) to protect financial institution investment in local communities by including investment grade municipal bonds in bank liquidity buffers. The bill is in response to a recent federal regulation that would force banks to exclude municipal bonds from the Liquid Coverage Ratio (LCR), which strongly discourages investment in municipal bonds.
In the wake of the 2008 economic downturn, federal regulators adopted international banking standards that require financial institutions to have enough High-Quality Liquid Assets (HQLAs) to cover their cash outflows for 30 days in case of a future financial meltdown. Unfortunately, under the new banking rules, municipal bonds are not — and cannot be — considered liquid assets. Therefore, municipal bonds cannot be included for purposes of the LCR Rule.
This regulatory misstep has discouraged financial institutions from holding municipal debt, and many are concerned this regulatory policy will force governments to reduce or even stop projects that are financed with municipal bonds.
“Democrats and Republicans understand that this bill is a big win for states and cities across the country, and our economy,” said Congresswoman Maloney. “Without this fix, critical local infrastructure and other projects could lack the financing they need to go forward, costing us jobs and hurting local communities. The decision to exclude investment grade municipal bonds from the liquidity buffer was senseless, and municipalities across the country were being hurt as a result. The Federal Reserve has concluded a fix is necessary, and there is strong bipartisan consensus in support of correcting this problem.”
“If our local leaders decide it’s important to build a new school, hospital, bridge or road for their residents, a federal regulatory misstep shouldn’t stand in their way,” said Congressman Messer. “This bill helps ensure cash-strapped school districts and municipalities will continue to have access to bonds to finance projects they think are best for their communities.”
“New York City's municipal bonds help keep our city running – from our infrastructure to our schools to our parks and more – while making for strong investments,” said NYC Mayor Bill de Blasio. “This bill will help ensure a fair and equal approach to municipal bonds and encourage the strong investment NYC and communities around the country need.”
“The City strongly supports legislation that would include municipal securities within the definition of High Quality Liquid Assets,” said Dean Fuleihan, Director of the NYC Office of Management & Budget. “For municipalities, which depend on the sale of bonds to finance critical infrastructure improvements, it is very important that banks be permitted to recognize the strength and marketability of those bonds.”
Gerrard P. Bushell, DASNY President & CEO said: “I applaud the House of Representatives’ action today, which encourages investment in the municipal bond market. Access to this market is absolutely critical for New York State and our local governments who use municipal bonds to build and maintain our roads, hospitals, schools and other important public infrastructure. I encourage the U.S. Senate to take action on this matter soon and send the bill to the President for his signature.”
H.R. 2209 requires banking regulators (The Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation) to treat liquid municipal bonds — i.e., those that meet all of the liquidity criteria in the Liquidity Coverage Ratio (LCR) rule — as “High-Quality Liquid Assets” (HQLA).
Following the financial crisis, federal financial regulators imposed new capital requirements on financial institutions to ensure that they have enough High-Quality-Liquid Assets to cash outflows for 30 days. Unfortunately, under these rules, municipal bonds were not considered HQLAs and therefore could not be counted towards an institution’s Liquidity Coverage Ratio. This would end up strongly discouraging investment in municipal bonds and cut off critical funding for states and cities.
While the Federal Reserve and FDIC have made progress to ensure fair treatment of municipal bonds, the OCC has thus far refused to act, necessitating the Messer-Maloney legislation.
H.R. 2209: This bill would level the playing field for states and cities by requiring the banking regulators to treat municipal bonds that meet the liquidity criteria in the LCR rule as Level 2A assets.
Liquidity Coverage Ratio (LCR) Rule: The LCR Rule requires banks to hold enough cash and highly liquid securities to survive for 30 days without access to any of its normal funding. In other words, the LCR ensures that banks have enough liquidity to continue operating even if everyone stops lending to the bank for 30 consecutive days.
High-Quality Liquid Assets: The LCR requires banks to hold a minimum amount of “High Quality Liquid Assets” (HQLA) — that is, assets that can quickly and easily be sold for cash in times of stress. In order to count as HQLA, assets must meet certain liquidity criteria laid out in the rule. The rule divides HQLA into three categories of assets: Level 1, Level 2A, and Level 2B.
1. Level 1 assets include cash and U.S. Treasuries, as the Treasury market is widely regarded as the most liquid financial market in the world.
2. Level 2A assets include U.S. agency securities, such as securities issued by Fannie Mae and Freddie Mac (also known as Government Sponsored Enterprises, or GSEs), as well as mortgage-backed securities (MBS) guaranteed by the GSEs. Level 2A assets are subject to a 15% haircut under the LCR (so if a bank owns a $100 agency security, only $85 counts towards its total HQLA).
3. Level 2B assets include certain corporate bonds and equities that meet the rule’s liquidity criteria. Level 2B assets are subject to a 50% haircut.
Municipal Bonds: Notably, state and municipal bonds are categorically excluded from HQLA — even municipal bonds that meet all of the liquidity criteria in the rule. This means that even if a municipal bond is objectively more liquid than a corporate bond, using the LCR’s own liquidity criteria, the rule would still treat the corporate bond as “liquid,” but not the municipal bond — purely because the municipal bond was issued by a state or municipality, rather than a corporation.
Fed vs. OCC: The Federal Reserve has already recognized that some municipal bonds are just as liquid as corporate bonds, and has proposed an amendment to its LCR rules that would allow certain municipal bonds to be treated as HQLA. The OCC, however, still refuses to amend its LCR Rule — which governs all nationally chartered banks — to allow liquid municipal bonds to count as HQLA.