The Federal Reserve's Liquidity Backstops to the Municipal Bond Market during the COVID-19 Pandemic



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Summary:

The COVID-19 pandemic has caused tremendous hardship all over the world. In response, the Federal Reserve has moved quickly and aggressively to support the economy in the United States. In this article, we present some initial evidence for the effectiveness of some of the facilities in calming the municipal bond market, particularly the short-term variable-rate demand obligation (VRDO) market. We discuss the important role of liquidity backstops in mitigating runs and stabilizing financial markets in general based on insights from our study on the runs on VRDO and auction-rate securities (ARS) in 2008 during the financial crisis.

Key findings:

The COVID-19 outbreak disrupted the U.S. municipal bond market in March as a result of a “flight to safety.” The aggressive emergency lending facilities of the Federal Reserve have helped calm the market. Based on insights from our study on the runs on the short-term muni market during the financial crisis, we discuss the important role of liquidity backstops in stabilizing financial markets in general.

JEL classification: G10, G20, G21

Key words: COVID-19 pandemic, liquidity backstops, municipal bond

https://doi.org/10.29338/ph2020-05



The Federal Reserve Bank of Atlanta's Policy Hub The authors would like to thank Nikolay Gospodinov, Mark Jensen, Paula Tkac, and Larry Wall for helpful comments. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility. Sign up for email updates at frbatlanta.org/research/publications/policy-hub.