The municipal bond market has calmed in the last two weeks as the flight from disaster ushers in a return to relatively safe havens.
But as two annual reports released by Moody’s on Thursday make clear, FY2011 and FY2012 could be when the financial crisis finally hits US state and local governments finances full whack.
This doesn’t mean widespread defaults, but it could prove a lagging drag on both the US economy and the Obama Administration’s policy agenda.
We’ll concentrate on the local government paper, as states’ fiscal fortunes are better known and because localities are set for a deeper and longer struggle.
There are four main reasons for this, writes Moody’s.
1. The ripple effect as states cut or delay payments to local governments.
Localities can’t bank on rising tax revenues over the next three fiscal years, according to this chart:
At the same time, states are cutting aid to localities, taking back revenues that were previously split, transferring expenditure responsibilities, and capping revenue raising capabilities.
2. Housing slump finally hits property tax revenues.
The report notes that property tax assessments are made 12 to 18 months before the revenues accrue to local governments. Hence, the first slump in receipts for 21 years is forecast in FY2011:
3. The low-hanging expenditure fruit have been picked.
“Many” local government workers have gone without salary increases in the last two years, says the rating agency. We’ve seen the previous troika of political no-no’s (education, police and fire) cut across localities. And, increasingly, assets are being flogged via lease-back deals such as this one in Newark, New Jersey:
An example is Newark (NJ), which issued lease revenue bonds in December 2010. With bond funds, the Essex County Improvement Authority, a conduit issuer with no taxing authority, purchased various buildings around the city of Newark and leased them back to the city for annual rental payments. The arrangement, which constituted deficit financing, provided $41.7 million to the city for its fiscal year 2010 (year-end Dec. 31).
4. “Enterprise risk”
This is when local governments “back the operations and/or debt” of non-governmental projects such as utilities. In the majority of cases these projects pay for themselves, but as Moody’s adds, there are exceptions:
An example is the city of Burlington (VT), whose GO was downgraded to A3 and Certificates of Participation to Baa1 and Baa2 in January 2011. The downgrade was driven by issues related to Burlington Telecom, a telecommunications enterprise. The enterprise’s prolonged operating deficits have been subsidized by the city’s pooled cash account, leading to reduced liquidity for the city and increased reliance on cash flow borrowing.
The report stresses that local governments retain tools — such as non-property taxes and fees — to raise revenue if needed.
But there’s little doubt that they will be a drag on a shaky recovery. And if anyone has come across a rigorous estimate, please ping it over.
Then there’s all that winning the future business. Granted, much of the lofty rhetoric from President Obama at the State of the Union looked far, far into the future, but it also focused squarely on education and infrastructure — two of the areas most vulnerable to the ripple effect. (We could also add the impact of medicaid cuts at a state level to his health care plan.)
All politics is local, after all.
Related links:
Munis coverage – FT Alphaville
A pause in the muni madness – FT Alphaville
Get specific on muni bonds, say Roubini analysts – FT Alphaville