Coronavirus aid lowered borrowing costs, credit quality: study

Federal pandemic aid stemming from the Coronavirus Aid, Relief and Economic Security Act of 2020, which flowed to county governments, resulted in slightly lower borrowing costs, reduced credit quality and a preference for short-term over long-term debt instruments, according to a study.

“Broadly, the findings indicate that recipient governments observed mild reductions in their borrowing costs and increased their debt issuance on the primary market, with no significant spillovers to the secondary market,” according to the paper, “Federal Assistance and Municipal Borrowing: Unpacking the effects of the CARES Act on Government Liquidity Management.” “This indicates that federal aid produced crowd-in effects for local governments that enabled the provision of local services.”

The paper, which compares county governments to state and city governments, was authored by Luis Navarro, professor of public and environmental policy at Indiana University, will be presented at this year’s Brookings Municipal Finance Conference.

Although governments in “the treatment group observed higher credit quality coming to the pandemic, during the post-intervention period they observed a significant deterioration on their average credit quality,” the paper said. One possible explanation could be “heightened uncertainty around the medium-term effects of the pandemic, where the market assigned higher risk premiums to bonds issued by governments more likely to experience adverse fiscal and economic conditions.”

In an interview with The Bond Buyer, Navarro noted it’s complicated because some county governments received money directly from Treasury, while others received indirect payments from their state governments. The paper deals with those that received money directly from Treasury.

The CARES Act expanded federal spending by $2.3 trillion and distributed $150 billion to state and local governments to help cover COVID-related expenses as well as alleviate near-term fiscal pressures. Each state received at least $1.25 billion and all county and city governments with a population above 500,000 received a direct payment from Treasury.

“The coronavirus relief fund provides a good setting to study this question as it creates a quasi-experimental setting in which, due to the eligibility rule established by the Treasury, some governments received direct aid from the CRF and some governments did not,” Navarro said. 

From April 2020 through December 2021, counties that received coronavirus relief funds observed a deterioration in credit quality. The paper also showed that governments that did not receive direct aid from Treasury increased their reliance on debt instruments of shorter maturities.

“It stands out that this substitution seemed to be larger among non-CRF recipients, thus providing some suggestive evidence on the role federal aid had on alleviating the liquidity pressures experienced by local governments at the onset of the pandemic,” Navarro said.

Results from the secondary market came back mixed and inconclusive, the paper said, but In the primary market, lower-rated governments, AA or A, observed larger spread reductions.

“Results for the secondary market, on the other hand, show some evidence on flight-to-safety behavior among investors as the estimates from the model imply a reduction on the trading volumes of debt with shorter maturities while, at the same time, there was an increase on the trading of longer-term bonds,” the paper said. “In particular, estimates for bonds of maturity above 20 years imply that trading of these bonds was 14 cents per capita larger (i.e. within 0.20x standard deviations of this variable, significant at the 5% level) for CRF recipients.”

Navarro expects similar patterns to emerge from looking directly at state and city governments, but “it remains unclear, however, to which extent the magnitude of the policy effects varies across levels of government,” the paper said.