Our take on Trump's sanctuary cities order and muni bond risks
Eaton Vance Municipal Insight Committee
Boston - President Donald Trump's executive order to remove federal funding from so-called sanctuary cities and states has caused concerns over their financing and municipal bonds. However, we believe that enacting such fund cuts would face significant legal and practical challenges, and the risks to muni bonds are low.
For background, "sanctuary city" is not an official designation but generally means those that limit their cooperation with immigration enforcement agencies. They include San Francisco, Chicago, New York and Denver. Some cities have already moved to challenge Trump's executive order, which states that sanctuary jurisdictions violate federal law to protect illegal immigrants.
Most importantly, President Trump does not have unilateral ability to withhold funding, so any cut in federal funding of sanctuary jurisdictions would need to be passed through Congress.
Looking just at California, although it does receive more federal funding than any other state, the majority of that funding goes to benefits for veterans, senior citizens, and the poor, which would be very politically difficult to cut.
From a legal standpoint, there is relevant case law in South Dakota v. Dole, related to the National Minimum Drinking Age Act of 1984. While the Supreme Court did uphold the constitutionality of the federal statute withholding a percentage of federal highway funding from states that did not maintain a minimum drinking age of 21, it placed clear cut rules for when this type of policy may be used.
President Trump's threats to cut all federal funding from California should it become a sanctuary state appear to violate several of these rules. The Supreme Court ruled that any withholding of funds from states must not be coercive, and that any funds withheld must be reasonably related to the condition the state is violating. In the case of California, this would mean that Congress would need to prove that all funds being withheld were reasonably connected to immigration enforcement.
Fitch Ratings said cutting federal funding to sanctuary cities would not likely have a rating impact on the cities since it represents a small portion of local revenues. The amount and method of implementation of proposed federal cuts is not clear, while civil and constitutional challenges appear likely to impede the implementation of the executive order, Fitch said.
Bottom line: We are continuing to monitor the potential impact of funds being withheld from sanctuary jurisdictions. Our current view based on the information available is that attempts to cut funding would either be limited enough in scope to be a non-factor from a credit perspective, or the cuts would face significant legal challenges that would delay their implementation.
An imbalance in supply and demand in the municipal market may result in valuation uncertainties and greater volatility, less liquidity, widening credit spreads and a lack of price transparency in the market. There generally is limited public information about municipal issuers. As interest rates rise, the value of certain income investments is likely to decline. Rising interest rates could reduce the value of the bonds in the portfolio, thus adversely affecting the value of the overall investment.
Originally Published at: Our take on Trump's sanctuary cities order and muni bond risks