How much debt can a state afford?
Washington State's legislature turned to treasurer Jim McIntire for an answer. McIntire delivered a 44-page ‘Debt Affordability Study’ that found the state's debt unsustainable. Only three of its peers had more debt – Massachusetts, Delaware and Florida. Washington is in the top ten of its credit peer group in debt owed, and is at twice the Moody's median debt levels no matter which measure is used: by per capita, as a percent of personal income, a percent of gross state product or a percent of the budget. Over the limit! Tapped! And this with $67 billion in infrastructure needs still unmet after five years. McIntire asked the legislature to form a group of policy makers from the legislative and executive branches to create a plan to manage the state's scarce debt capacity.
State senators on the Capital Budget Committee responded to McIntire with Bill #8215, which would lower the State's debt limit by half percent increments starting in fiscal year 2016. If the bill is passed by both houses, voters will have to decide on its future in the first general election, in this case November. State Houses and taxpayers across the country will no doubt be following the fate of #8215, to see whether Americans are willing to do two things they probably haven't been asked to do since WWII: sacrifice and defer reward.
How will the #8215 plan would work? The bill would lower the limit the state can borrow for capital projects from 9 percent to 7 percent of the mean of the general state revenues over the three preceding fiscal years. Conversely, if employment drops below 1%, following two years of low employment growth, borrowing would be allowed to creep over 7 percent toward the 9 percent limit. A joint version of the bill is under review by the Senate Committee on Ways & Means and is expected to pass the Senate, according to a Treasury Department spokesman. There seems little choice judging from proponents' testimony that if the current borrowing policy is continued the state will reach a point where 7 percent of the its general funds will go to service its debt.
But not everyone thinks that's a big deal. “Any family would love to have a mortgage payment amounting to 6% of their income,” says Stan Bowman, the executive director of the American Institute of Architects’ Washington Council. He feels the state has contributed to its own fiscal woes by not funding enough nonresidential construction. The state had the opportunity to boost design and construction spending, says Bowman, but yielded instead to “the pressures on other parts of the budget; public employee unions asking for raises and benefits and education advocates ... Do we fund the social welfare programs or do we fund construction?”
The goal, says Bowman, is “worthy” in setting up a rainy day account to provide excess capacity to keep things going in a downturn. But, he adds, “it guarantees lower construction spending going forward, yet there's no guarantee that construction spending would increase in bad economic years.”
It's hard to argue. Construction jobs nationally are at record lows. An ADP survey released on March 30, 2011, showed the country lost 2,126,000 construction jobs since January 2007.
Bowman doesn't trust the state to raise the debt percentage limit in those down years. “We have to look at past history,” he says. Bowman contends that the state legislature “swept” $1 billion of the biennium budget for construction out of construction-dedicated cash accounts, such as the Public Works Trust, which funds infrastructure work, in order to fund social programs. It is illegal to apply bond funds to operational expenses.
“The legislature swept the cash accounts and backfilled some of those projects with the bond money,” insists Bowman. “It was a shifting away [monies] from construction. So that was legal: It wasn't wise, but it was legal.” Requests for comment regarding Bowman's allegations left with staff and a call and an email directly to Senator Derek Kilmer, vice chair of the Capital Budget Committee and a sponsor of Bill #8215, were not returned.
Wall Street has yet another view of what #8215 would do for the state's credit profile. “A decrease in the state’s debt burden over time would have a positive impact on the market’s perception of its credit, and, because Washington has a good history of managing its finances, a rating upgrade to AAA would not necessarily be out of the question,” says John Updegraff, executive director and municipal analyst at JP Morgan Asset Management. “For example, Florida has a sales tax based revenue stream and is Aa1/AAA despite its recessionary travails.” Also a reduction in bond issuance, says Updegraff, “would have a positive impact on spreads, at least at the margins.”
Similarly, if rates rise and munis become cheap, through lowered repayment risk, traditional buyers may return to the market. Updegraff cites January of this year, when “you could have bought tax-exempt Washington general obligation bonds at Treasuries +80 basis points. At the same time, A-rated corporate bonds were treasuries +70. This was extremely compelling for crossover buyers.”
Updegraff paints a convincing picture of the carrot that awaits Washington's long-term austerity plan. But who will be making the sacrifices and in what proportion remains to be seen.
Meanwhile, Bowman says the legislators were interested in his group's comments, “took them to heart and indicated that they understand our concerns. They just haven't figured out how to deal with those concerns.”
