President Trump has fulfilled a campaign promise by signing an executive order declaring that sanctuary cities will no longer receive federal funds except as mandated by law.
Could this impact municipal bond holders?
The early read from the bond market is that, at this point, the executive order is more bark than bite. Let's look at why.
What Is a Sanctuary City?
The term refers to the cities (and counties, and states) across the US that limit their cooperation with federal immigration authorities by refusing most requests to detain, pursue or report undocumented immigrants who have had contact with local law enforcement.
According to The New York Times, sanctuary "cities" include major metropolitan cities like Baltimore, Boston, Las Vegas, Los Angeles, New York City, San Francisco and Washington DC); but also more than 360 individual counties (including much of California, Oregon, New York and Washington) and even entire states (California, Connecticut, Oregon, Rhode Island and Vermont). The term city is used in name only ---- meaning there are laws on the books at the county or state level protecting undocumented immigrants from deportation. There are even scattered sanctuary jurisdictions in very red states, such as Arizona, Georgia, Kansas, Kentucky, Nebraska, North Dakota and Texas. It is significant that there are so many counties, since counties typically run jails.
Together, these jurisdictions make up a meaningful portion of the municipal bond market.
Credit Risk to Municipalities
Ratings firms have said that even after the order was signed, they don't see a major threat in the near future to municipal borrowers' ability to repay their debts. Why? For one thing, the executive branch has very limited power to withhold or defer funds already appropriated by Congress. Most federal dollars that go to cities are based on statutory grants that follow a formula and can only be stopped if the funds aren't being spent on the intended purpose. For example, ignoring federal immigration policy wouldn't justify halting a Head Start grant for early childhood education.
President Trump cannot, by himself, change the funding formulas to affect any local government.
Which means he would need help from Congress, and although Republicans control both houses, it's unlikely that Congress will pass a new law forcing sanctuary cities to follow President Trump's immigration policy. Similar bills were introduced in the last Congress and failed to pass. At least four jurisdictions have already filed lawsuits alleging the executive order is unconstitutional. Even if a bill were to pass it could be overturned by the Supreme Court as we saw in the Obamacare case. (The Supreme Court ruled that the federal government could not withhold Medicaid funding from states that didn't use the Affordable Care Act because it was "unconstitutionally coercive.") But perhaps more importantly, enacting new legislation in the first place will likely be problematic. Politicians who seek reelection, may find it fairly unpopular to cut off funding to child care programs as punishment for how cities and counties manage their jails.
We will continue to watch how President Trump's desire to effect change on immigration policy plays out, but as Guy Davidson, director of municipal investments at AllianceBernstein has said, "The muni market's view on this is it's not good, but it's not necessarily a credit risk."
