Cities, Towns & Villages

States Poised to Withstand Economic Challenges


(The following article is based on a recent speech by Robert Kurtter, presented at Smith’s Research and Gradings “State and Local Government Finance Conference,” as well as a subsequent interview with Mr. Kurtter.)

Despite a slowdown in the national economy, the overall credit trend for states is stable despite revenue weakness, continued spending pressures and an uncertain national economy, according to Robert Kurtter, Managing Director of State and Eastern Regional Ratings at Moody’s Investors Service.

Over the course of the past year, six states have been upgraded – including North Carolina and Vermont, both now AAA-rated credits.

Debt issuance is up 23.4% for the year to date (through October 2007), mostly due to new money borrowing, a high level of refunding, and an increase in tax-supported debt.

Time to tighten the belts …

In the 1990s, a booming stock market led to a strong economic growth throughout the U.S. Many states saw revenues skyrocketing, over-performing estimates and prompting increased spending. In the summer of 2001 – even before 9/11 – the stock market tumbled, causing a financial collapse with implications throughout the country. In 2001 and 2002, many states found themselves in serious financial trouble, experiencing huge deficits.

While the markets rebounded for a couple of years, prompting a renewal in spending, we are currently seeing a softening in our nation’s economy – though “certainly less dramatic than the meteoric rise and fall of 2001-2002,” says Kurtter. The challenges facing states nowadays are not of the same magnitude, but in light of the country’s economic slowdown, many states will have to tighten their belts and adjust spending.

And some states have more tightening to do than others, in Kurtter’s view …

  • Florida and Virginia, for example, were really booming over the past few years, but then both faced unexpected slowdowns in their respective economies, initiated by downturns in overheated residential real estate markets.
  • Michigan, perhaps the most laggard of the states, never boomed, yet still experienced a minor bust – from which it has yet to recover. And rising energy costs, which will likely impact auto sales, will make Michigan even more vulnerable going forward, particularly due to its economic dependence on domestic auto sales.
  • New York and New Jersey have been – and still remain – dependent, to some extent, on Wall Street profitability; therefore, the performance of the markets will impact their respective economies as well.
  • California is already feeling the pinch of the housing market and sub-prime mortgage crisis.
  • Illinois’ revenue growth is slow, but close to forecast amounts.The state expects generally weak performance of sales, corporate, and personal income taxes due to the overall slowing economy and the weak residential real estate market.

A few states are in a position that is less vulnerable to the overall economic slowdown.

  • Energy-producing states – like Alaska, Louisiana and Oklahoma, for example – are receiving a revenue boost from taxes due to rising oil and gas prices, and therefore, are a little less vulnerable to the slowing U.S. economy.
  • Louisiana and Mississippi are both still benefiting from the stimulative economic effects of rebuilding from hurricanes Katrina and Rita – including insurance monies, federal aid, and charitable contributions flowing into the state, creating a positive economic impact from the rebuilding of their communities.
  • Texas is the singular large state that appears to be doing well despite the national economic slowdown, primarily largely due to the still large oil and gas sector in the state.

What’s the outlook for state finance?

On the positive side, Kurtter says, employment growth appears to be slow but sustainable. While corporate tax revenues are a bit more volatile, sales tax growth as a result of consumer spending also looks stable, although there are risks that consumers may be reining in their spending as they see the value of their homes decline or stop growing.

School funding pressures, rising energy costs, and Medicaid burdens also have the potential to adversely affect states’ financial viability as they struggle to balance weaker revenue growth with the still strong demand for popular programs like education funding and rapidly rising healthcare and energy costs.

Because states have been fairly conservative in their spending, and have kept their debt burdens in check, most will find themselves well-positioned to handle these challenges.

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