Maryland's debt threat

O'Malley touts state's high credit rating, but how long will investors believe what these agencies say?

May 25, 2010|By Marta H. Mossburg

"You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of f—— bond traders?"

President Bill Clinton asked that question, according to Bob Woodward in "The Agenda." Mr. Clinton was referring to the fact that if bond traders did not like his programs, they could stop buying debt and send interest rates climbing, souring the economy.

At the state level, Gov. Martin O'Malley is equally beholden to bond traders, who, to his benefit, pick Maryland like a greasy bucket of finger-lickin'-good fried chicken.

He's lucky. Investors' willingness to scoop up state debt is a big reason Mr. O'Malley has been allowed to defer hard budget choices and paint himself as fiscally responsible.

Exhibit A: The state's stellar credit rating has allowed it to borrow hundreds of millions to pay for capital projects that should have been paid for in cash. This means that today's streets are paved with tomorrow's taxes. It also means revenue collected to upgrade wastewater plants, for example, is used for other purposes in the general fund, with bonds issued to replace the cash.

This can go on so long as credit ratings agencies keep giving Maryland the highest score possible — AAA — and investors keep believing their research. These are the same agencies now under congressional scrutiny for repeatedly giving AAA ratings to thousands of securities based on subprime mortgages held by people who could never repay them. It is also the same group of agencies upgrading thousands of governments across the nation in recent months even as state and local finances deteriorate.

Given their past performance, it defies rationality why investors would still consider one of the big three agencies' state or municipal AAA ratings — or even a less admiring one — as anything but intellectual Spam.

But don't take my word for it. Let's take a look at state finances.

One criterion that ratings agencies use to calculate a score is outstanding bond debt as a percentage of personal income. In Maryland, it works out to about 3.4 percent. The state caps it at 4 percent — a level which it considers "affordable."

But the agencies should not be paid to hold states to their own standards. They are supposed to be able to evaluate all risk, including much more expensive long-term obligations like unfunded pension and health care liabilities for state employees and retirees, as well as needed upgrades to transportation networks.

In Maryland, outstanding bond debt is $9.5 billion. Unfunded pension and health care liabilities are about $30 billion, and if those costs were included in the "affordability" ratio, it would mean that long-term debt would equal more than 14 percent. Consider the $40 billion in planned transportation projects that are not funded but can't be put off forever, and Maryland's long-term fiscal situation looks even worse.

Richard Ciccarone, a co-founder and past president of the National Federation of Municipal Analysts and managing director of McDonnell Investment Management in Oak Brook, Ill., said the fact that Maryland has been under-funding its pension plan for years is "not a fact one would expect of a state with an AAA rating." According to his research, the pension funding went from 91 percent in 2004 to 64.2 percent in 2009.

To be fair, the ratings agencies consider the state's response to unfunded pension and health care liabilities. But they also rely heavily on the fact that few municipalities have defaulted. As we learned from the housing crisis, real estate prices don't always go up, and who can guarantee legislators can always raise taxes — one of the state's key ways to balance the budget and make the agencies swoon?

Worse, according to a March report by the nonpartisan Citizens Budget Commission in New York, Maryland ranks 13th worst of the states on the affordability of its long-term debt. If an AAA state like Maryland is in such bad shape, what does it say about New Jersey and New York — two states considered in the "danger zone" for not being able to afford their debt and whose economies dwarf that of Greece, whose bankruptcy is now roiling markets across the globe?

As Congress sorts through potential reforms, what's clear is that the current ratings system not only prevents investors from finding out the true financial position of states and municipalities, but it encourages government to spend beyond its means by making it too easy to issue debt.

When traders realize the true financial position of states, investors and taxpayers beware. If Mr. O'Malley is lucky, it won't happen until after he is re-elected.

Marta H. Mossburg is a senior fellow at the Maryland Public Policy Institute and a fellow at the Franklin Center for Government and Public Integrity. Her column appears regularly in The Baltimore Sun. Her e-mail is martamossburg@gmail.com.

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