The Federal Reserve is expanding its asset purchases to include municipal bonds

Muni bond ETF MUB down 13% in last two weeks
Muni bond ETF MUB down 13% in last two weeks

The Federal Reserve said Friday it would extend its asset purchase program into short-term municipal bonds.

Thus far, the central bank has limited its efforts to Treasurys and mortgage-backed securities in an effort to keep liquidty flowing through the system and to stabilize credit markets. 

However, continued disruption in the markets for state and local government debt promoted the Fed to take further action in its efforts to combat coronavirus effects. The market for munis this week has all but collapsed, with few willing to step in and buy the government debt in the uncertainty of the current climate.

In a statement, the Fed said the move is "to enhance the liquidity and functioning of crucial state and municipal money markets."

The program will work through the Money Market Mutual Fund Liquidity Facility announced earlier this week and offers an expansion of what had been a financial crisis-era program authorizing purchases of other assets. Expanding into munis is something that did not happen during the crisis.

The Boston Fed will lend to eligible banks and other financial institutions that will be able to use single-state and other tax-exempt munis as collateral. Maturities can't exceed 12 months.

The S&P Municipal Yield price index has tumbled 7.1% over the past week and was off 4.2% in the day before the Fed made the announcement.

The Fed had previously announced a $700 billion asset purchase regime involving $500 billion in Treasurys and the remainder in MBS.