Downgrade for Maryland bonds looks likely

August 08, 2011|By Jay Hancock

The next shoe on the ratings-downgrade centipede dropped Monday, as Standard & Poor's followed Friday's landmark lower credit score for U.S. Treasury bonds by assigning an equal downgrade to Fannie Mae and Freddie Mac.

The bonds sold by those mortgage giants are less reliable now thanks to their "direct reliance on the U.S. government," said S&P, a large debt-rating agency.

Perhaps one should assume that other borrowers with direct reliance on Washington have also become slightly shakier credits. Such as a small state just north of the Potomac that benefited from more than $80 billion in federal spending in fiscal 2009, the most recent year for which figures are available.

Maryland's loss of its top-shelf AAA rating from S&P and other agencies is not assured, but it's looking much more likely. Lower ratings indicate a higher risk of default and could move investors to demand a higher interest rate than the 3 percent or so that Maryland has been paying recently.

A downgrade could cost the state something like $10 million per year for every $1 billion in new general obligation debt issued, according to Warren Deschenaux, the General Assembly's chief budget analyst. With up to $5 billion in Maryland general obligation bonds scheduled to be sold in the next five years, that's real money.

Deschenaux was sounding optimistic on Monday about Maryland's rating, at least for the near future, noting that S&P has a history of warning borrowers before it moves — and hasn't done so. Also, he said, Maryland isn't scheduled to sell new bonds until next year.

"S&P is not taking action against us at the present time," Deschenaux said. If they haven't put Maryland on notice for a possible downgrade, he said, "they're probably not going to do that in the near term."

Certainly S&P's most recent report — July 13 — gives little cause for alarm on bonds backed by the full faith of the Maryland taxpayer.

The state has a "long history of prudent fiscal management," S&P said. It has "a strong, diversified economic base." It reformed its pension system this year and boasts "strong wealth and income levels, coupled with unemployment that remains below the national average through economic cycles," the agency said.

There's barely any mention of where an enormous portion of the wealth and income comes from — Washington. One in 18 Maryland jobs is with the federal government. Tens of thousands more state residents are indirectly employed by the federal government through private contractors. All those jobs support employment at car dealers, grocery stores, banks and so on.

Moody's, another major ratings agency, raised concerns about Maryland's federal exposure on July 19. Unlike S&P so far, Moody's put Maryland under review for a possible downgrade, noting the state's dependence on federal employees and procurement contracts.

And Moody's made very clear that if it lowered the credit score a notch for U.S. Treasury debt, it would probably look at the bonds of Maryland, Virginia and three other states dependent on federal spending (New Mexico, South Carolina and Tennessee) in a different light, too.

"Should the U.S. government's rating be downgraded … these five states' ratings could likely be downgraded as well," the agency said. "Moody's will review the ratings of the five states on a case-by-case basis and announce any rating actions within seven to ten days" after downgrading Treasuries.

Last week Moody's maintained its top score for the federal government. So the question of whether it would downgrade Maryland and the other states would seem to be answered, at least for now.

S&P, on the other hand, did downgrade Washington. And there is little reason to doubt that its analysts are now looking more closely at Maryland and other federal-dependent states.

I was unable to talk to anybody at S&P. Both of its main Maryland analysts were out of the office Monday. A spokesman was unable to set up an interview with anybody else.

But the outlook for all kinds of securities would seem to be, in bond raters' language, negative. Investors gave their own poor grade to stocks on Monday. That has implications for Maryland and every other state that invests in stocks to meet pension obligations.

Maryland's finances are far better run than the federal government's. Maryland doesn't issue debt to close budget shortfalls. It doesn't borrow wildly. It doesn't commit to huge new programs without finding the money to pay for them.

Unfortunately, it depends heavily on Washington, which does.

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