Supporting less prosperous brethren
There are many financial linkages between various levels of government in muniland but everyone eventually has to stand on their own. It’s like the cousin you grew up with but don’t see much now other than holidays. When your cousin loses their job and their mortgage is being foreclosed you want to help but in a limited way. You want the cousin to get a job and cut a deal on their mortgage or do a short sale. You don’t want them moving into your home or having access to your bank account. It’s the same between the federal, state and local governments. They are cousins. But not that close.
My fellow Reuters blogger, Felix Salmon, said yesterday that states are considered too-big-to-fail by the financial markets:
There’s certainly a general understanding, in the markets, that California is too big to fail: if push came to shove, the federal government would bail it out rather than let it default.
This is entirely contradictory to how the government views the matter. I have heard numerous times from members of Congress that they have no interest in bailing out states. In fact Congress has not brought up legislation to give states the right to default that was promoted by former presidental candidate Newt Ginrich last January. Reuters reported:
Legislation that would allow U.S. states to file for bankruptcy will likely be introduced in Congress within the next month, Newt Gingrich, the former speaker of the House of Representatives and a powerful Republican party figure, told Reuters on Friday.
For months he has championed letting states file for bankruptcy in order to handle their long-term budget problems despite resistance from states and investors in the $2.8 trillion municipal bond market.
I don’t believe this legislation was even filed let alone assigned to committee to have hearings held.
Ben Bernanke, Chairman of the Federal Reserve has stated numerous times that he has no appetite to assist states. Reuters reported that Chairman Bernanke explicitly said in January that the Fed would not do this:
Federal Reserve Chairman Ben Bernanke on Friday once again said he opposes providing financial aid to the many states still reeling from the economic recession.
Bernanke firmly said “No” after being pressed by Democratic Senators to consider a lifeline from the central bank for states where economic recovery remains elusive.
“They should not expect loans from the Fed,” Bernanke said while testifying before the Senate Budget Committee. “It’s going to be difficult, but on the other hand there is some improvement in the economy and tax revenues have actually picked up.”
Rather than directly loaning money to a state the Federal Reserve could buy it’s municipal bonds as a way of suppressing the borrowing cost for the state. That would seem the most likely action of the Federal Reserve in support of a state. I’ve not heard of the central bank having any municipal bonds on it’s balance sheet though.
There is also some confusion about how credit ratings for various levels of government interact. Often governments at lower levels have higher credit ratings than the government above them. Felix said:
The way that credit ratings work, any municipalities which currently have triple-A ratings would almost certainly lose those ratings were the US sovereign to be downgraded. As far as I know, there’s no precedent for a sub-sovereign entity to have a higher rating than the sovereign, except in extreme cases where the sovereign is actually in default.
This is wrong. Think about rich cities in poorer states. Silicon Valley is much more well to do than the state of California. And if California were downgraded from their A1 credit rating the communities in Silicon Valley would retain higher ratings if the tech and VC industries remained strong.
The chart at the top shows credit ratings for major cities in America. In three out four instances the cities have higher ratings than the states. There are many factors that can flow into the rating downgrade of a public entity in muniland. Every cousin is not equal. Some have better educations, bank accounts and employment histories. And it’s a matter of personal preference whether they will support their less prosperous brethren.