National credit downgrade may spread pain locally

Kavin Matthews

10/01/2011

The United States’ debt crisis has affected many regions across the country, not the least of which is Rhode Island.
The debate over the raising of the national debt ceiling was more than a national political squabble. It had serious potential consequences for states’ budgets, including Rhode Island’s. If the federal government had entered into a technical default on its debts, then the chance of the economy spiraling back into a recession was extremely high. And if this had happened, Rhode Island’s slow recovery would have been short-circuited, leading the state back into recession and continued high unemployment.
The stripping of the nation’s AAA rating by Standard and Poor’s is not doing much good, either. Although a technical default has been averted, the bickering over the methods of collection of money for compensating the increase in debt ceiling and avoiding a situation like this until 2013 has led to deep gashes in the economy.
In fact, the downgrading of the U.S. bond rating may result in a domino effect across the country, according to Leonard Lardaro, the University of Rhode Island economist. As one would expect, the downgrade brings with it an implied increase in the risk of U.S. debt. In turn, state and municipal debt may be perceived as even riskier, which would likely lead to additional downgrades in the bond rating of the state and its 39 cities and towns. And inevitably, the cost of borrowing money would increase.
Mr. Lardaro’s assessment was voiced and supported by many other local experts. Gary S. Sasse, director of Bryant University’s Institute for Public Leadership, but also the former director of the R.I. Department of Administration and former head of the Rhode Island Public Expenditure Council, said that the damage done to the U.S. would lead to negative effects on both public agencies and individuals. According to Mr. Sasse, if the U.S. borrowing costs rise, state and municipal bond prices could be affected. A more direct effect of fiscal crisis at the federal level could be the loss of direct federal aid to the states. Rhode Island’s budget depends on federal funding, much of which appears to be at risk. Even delays in federal disbursements can have a serious effect on state governments, which either have to curtail services or borrow more to cover existing commitments.
Mr. Sasse also feared that the effects of a federal crisis could spread beyond state and local governments. A decline of the equity markets due to a lack of confidence in the national government inevitably will be felt by pension funds as well as personal investments. The state pension system could lose billions of dollars due to lower return on investments, something that has been observed recently as the Great Recession played itself out, as the state pension system lost $1.5 billion, or 19.2 percent of its value, during the 2008-2009 period.
So the next time you see dysfunction in Washington, don’t assume its effects will remain there. They could make a big difference in your life as well. •

Kavin Matthews is a financial consultant and analyst based in Denver. His writings can be found at http://www.facebook.com/debtcc.

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