On September 27, 2016 a bipartisan group of Senators led by Sens. Mike Rounds (R-S.D.), Mark Warner (D-Va.) and Chuck Schumer (D-N.Y.) introduced legislation (S. 3404) to allow high quality municipal debt to be classified at a level equivalent to debt issued by corporations. The legislation is part of a congressional response to a rule established in 2014 by the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency (OCC) that established minimum liquidity requirements for large banking organizations. The rule identified high quality liquid assets (HQLA) that banks could hold to meet the requirement. Unfortunately, despite including instruments such as foreign sovereign debt among the acceptable investment categories, the rule excludes investment grade municipal securities from its definition of HQLA.
The purpose of the rule is to prevent future financial crises similar to what the market experienced in 2008-2009 by ensuring that large banks maintain a certain level of liquid assets that could quickly be converted to cash during times of national economic crisis. However, as the rule is currently designed, debt sold by states and local governments does not count as HQLA and large banks are not able to count them towards the rule’s requirements.
Under the rule, liquid assets could fall into one of three categories: Level 1, Level 2A and Level 2B. Level 1 includes securities like U.S. Treasuries and low-risk foreign sovereign debt. Level 2A includes securities like those issued by U.S. government-sponsored enterprises and higher-risk foreign sovereign debt. Level 2B includes securities like corporate debt. Not recognizing municipal securities in any of these categories creates a disincentive for banks to hold them, which may result in increased costs for state and local governments to issue bonds for critical needs like infrastructure.
Earlier in 2016, the U.S. House of Representatives approved similar legislation by voice vote. H.R. 2209, led by Rep. Luke Messer (R-Ind.), would call for investment grade municipal securities to be recognized as a level 2A liquid asset under the rule. The Senate did not act on H.R. 2209. S. 3404 differs slightly in that municipal securities would be recognized as level 2B rather than 2A. Also joining as original cosponsors of S. 3404 are Sens. Mark Kirk (R-Ill.), Jon Tester (D-Mont.), Tim Scott (R-S.C.), Heidi Heitkamp (D-N.D.), Joe Donnelly (D-Ind.), Jerry Moran (R-Kan.) and David Vitter (R-La.). The bill could potentially see action when the Senate returns after the elections. NACo will continue to monitor the bill’s progress and report any developments as they occur. Further, we will continue to work with Congress to protect counties’ ability to finance key public projects.
Contact: Mike Belarmino at email@example.com or at 202.942.4254