WASHINGTON, May 20 (Reuters) - The U.S. Federal Reserve is still reluctant to help struggling states and cities with their finances and "has important misgivings" about providing them with credit support, the central bank's deputy research director plans to tell a Congressional hearing on Wednesday.
According to David Wilcox's testimony posted to the House Financial Services Committee's Web site, the Fed believes "the monetary easing and the fiscal stimulus will continue to provide important support to the overall level of economic activity in coming months -- a critical determinant of the fiscal condition of state and local governments."
Over the last 15 months, the central bank has eased the federal funds rate target to virtually zero percent while Congress has passed two economic stimulus bills.
Even then the municipal bond market has remained stressed, with lower-rated cities and states facing higher debt costs, Wilcox says. Bond insurance, which was once used to boost those ratings, is rarely used after all the guarantors lost one or all of their top ratings.
Help should come from other areas, according to Wilcox.
"Many of these potential policy responses likely would require fiscal action -- such as grants to municipalities or the creation of new federal insurance or reinsurance programs... -- and thus are properly in the realm of the fiscal authorities," he says.
Throughout an extended crisis in the municipal bond market, which included the collapse of auction-rate securities and a virtual freeze in debt issuance, Fed Chairman Ben Bernanke has asserted the central bank should not intervene.
Many state and local governments have seen their revenue drop and spending pressures rise due to the economic recession and have been unable to turn to their traditional last resort of issuing debt to raise money. They have repeatedly called on the Fed or the Treasury Department to intervene.
Financial Services Chairman Barney Frank will introduce legislation at the hearing to create a special purpose vehicle supported by the Federal Reserve that would finance standby purchase agreements for variable-rate demand notes.
Wilcox, though, encouraged Congress to consider "the degree to which government involvement in this market is appropriate in the long term."
"Because contracts for liquidity support are typically of short duration, municipalities face significant 'rollover' risks for their VRDOs that raise serious questions about whether these securities should remain a significant vehicle for municipal finance," he says.
(Reporting by Lisa Lambert; Editing by Diane Craft)
