As the Federal Reserve came under fire yesterday over administration of its Municipal Liquidity Facility, a Fed official confirmed that the central bank has evaluated the purchase of closed-end muni-bond funds to help stabilize the market.

"I wouldn't want to go into too much detail in terms of the types of interventions we've been evaluating [but] we are prepared to act if necessary," said Kent Hiteshew, a deputy associate director at the Fed, during a Congressional oversight hearing.

"Closed-end funds, and other ways of accessing or intervening into the secondary [municipal] market have been evaluated, but I wouldn't want to go further on that," he said.

Hiteshew's comments came in response to a question from Rep. French Hill (R-Ark.), a member of the CARES Act Congressional Oversight Committee. The CARES Act, signed into law in March, authorized the MLF and other support programs.

The Fed has already purchased corporate bonds and high-yield ETFs in response to the mayhem caused by the outbreak of the Covid-19 virus in March. Buying bond ETFs was a first for the central bank. A similar action into municipals would also be unprecedented--but tricky.

"Suffice it to say that the secondary intervention in the municipal markets would be complex," Hiteshew said, given the idiosyncratic nature of the market.

Hill suggested that the larger size of the closed-end muni-fund market versus tax-free ETFs made closed-end funds a possible vehicle for Fed intervention.

Fed action in the secondary municipal markets seems unlikely, though. The MLF serves strictly as a backstop to newly issued short-term funding notes. The Fed was authorized to purchase up to $500 billion of municipal notes, but has so far committed only $1.65 billion, a sore point with the two Democrats on the four-person oversight board who want more support for state and local government.

Hiteshew defended the facility, saying it was successful in calming the market without replacing private underwriters. Hiteshew is a former municipal bond banker and Treasury official who joined the Fed staff in March to work on the MLF.

Moody's Analytics chief economist Mark Zandi, also testifying before the oversight board, urged the Fed to lower rates and loosen the MLF terms to encourage more lending. Zandii added further federal support to states and cities looks unlikely.

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