The Debt Deal: Hard truths and silver linings for local governments

As local government officials begin to sort through last month’s dramatic spending reduction deal (the Budget Control Act of 2011) and the impacts of New York-based Standard & Poor's (S&P) Ratings Services’ subsequent lowering of the federal government’s long-term credit rating, it’d be easy to simply give in to the negative media coverage and accept that the end of federal assistance programs and robust municipal financing has come.

Quite honestly, a cursory view of last month’s developments would make even the most optimistic finance director cringe. For starters, most headlines coming out of Washington would have you think that federal assistance to state and local governments has officially dried up. Similarly, much of the coverage regarding the subsequent downgrade to the nation's credit rating seemed to suggest that state and local governments would soon begin defaulting in droves and that the municipal bond market was on the verge of collapse.

Silver linings
But, before you resign yourself to darker days ahead, it’s important to take a step back and grasp what last month’s developments really mean for both the federal government and local government. What are the real effects?

For now, it’s clear that federal aid to states and local governments for certain programs will take a hit over the next decade. What we (and most others) don’t know is when the hit will come, how much it will be, and which programs will be affected by the decision to slow the flow from the federal spigot.

That’s because while the current plan calls for $917 billion in deficit reduction over the next decade by immediately setting caps on discretionary spending, how exactly to meet those caps — and what funds to states and local governments might be cut — is a question for Washington to answer another day. Similarly undetermined is how much the joint congressional committee charged with finding another $1.5 trillion in deficit savings would cut from aid to municipalities.

With regard to the impact of the federal credit downgrade, we know now that even though S&P's proclamation was meant to reflect growing risk in the ability of the federal government to pay off its debts, investors have not shied away from the traditionally safe investments. In fact, the yields on Treasury bonds have actually fallen since S&P downgraded the nation's debt, as more investors have bought the securities in search of a safe haven from risk. Kind of ironic if you think about it!

In addition, Moody's Investors Service and FitchRatings both confirmed the nation's AAA credit rating following an increase to the debt limit, but also noted that downgrade could be on the way if Congress does not follow through on its promises.

But while the attention of most observers right now seems divided between Washington and Wall Street, much of the effects of the debt deal are and will be occurring at the state and local levels. That being said, lets take a look at some of those silver linings that matter to local governments.

Local government budgets are largely independent of the federal government
Despite all of the doom and gloom, the impact of New York-based Standard & Poor's (S&P) Ratings Services’ lowering of the federal government’s long-term credit rating to AA+ with a negative rating outlook has not affected state and local government ratings uniformly.

While S&P subsequently announced another wave of downgrades last month, lowering the credit ratings that affect thousands of cities, school districts, public housing and transportation projects, those entities were directly linked to federal funds or are paid from funds appropriated at the federal level.

More important is the fact that S&P last month reported that its downgrade of the overall nation does not necessarily mean all the top-ranked states and localities need to fall as well. While state and local governments do receive help to shore up their books with assistance from the federal government, S&P affirms that state and local finances are largely independent of the federal system. [View S&P Report: http://goo.gl/ZtNlt ]

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