Moody’s has acknowledged the obvious: state and local governments are weaker credits as a result of cuts in federal spending, a weak economy and diminished state aid. The Great Recession is not through with state and local governments, and the credit rating agency finally acknowledged as much. Budget imbalances at all levels of government, underfunded pension and unfunded healthcare benefits and weak tax collections have combined to increase the risk associated with these historically safe borrowers.
Moody’s did go on to note that it does not expect defaults or chapter 9 bankruptcies, but given the deal that Jefferson County’s bondholders have accepted, that should not be encouraging.
A recent article by Penelope Lemov highlights many of the issues that state and local governments are facing:
- U.S. Credit Downgrade: It is an open question just for how long state and local governments will be permitted to maintain a credit rating higher than the U.S. government. In the end it is absurd to believe that 15 states (as of August) represent a better credit risk than the U.S. government.
- Chronically Imbalanced Budgets: Revenue weakness and lack of spending discipline have now forced many state and local governments to consider axing programs once considered untouchable. The gap between considering these steps and taking them, however, is a crucial one.
- GASB and Pensions: Sunlight may be the best disinfectant, but disinfectants have a tendency to sting. The increased transparency into pension liabilities that new GASB rules would bring about could, during this period of economic weakness, offer up the opportunity to restructure these liabilities. But doing so will not be easy.
State and local governments are not magic entities, and their historically low default rates do nothing to prevent default rates being substantially higher in the coming years. We are on the cusp of a double dip recession and state and local governments throughout the country are teetering on the brink. Defaults, de facto and de jure, are guaranteed; as are restructurings whether they take place in or out of court.
About the author:
David Johnson is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services to companies and municipalities. He can be reached at 312-505-7238 or at [email protected].
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