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Paterson Takes on Debt

New York Gov. David Paterson wants to break the state's debt addiction. If he has his way, pay-as-you-go financing will overtake debt as the primary vehicle for capital financing by fiscal 2014.

It may be good fiscal policy, but moderation is one of the few options New York has. According to Division of Budget revenue and debt projections made in October, the state would exceed its statutory debt cap in fiscal 2013 unless it cut back on borrowing or total personal income in the state rose, or the law was changed.

Borrowing for capital needs isn't going away any time soon, but Paterson's budget and five-year capital plan released earlier this month charts a long-term course that will rely less on the credit markets than it does now.

"Access to the market might not be the given that it once was," said Emily Rames, an analyst at Moody's Investors Service. "With the markets the way they are, it's something that a lot of issuers are starting to look at for the first time in a long time."

Currently, the state bonds out 59.1% of its capital financing while using state and federal pay-as-you-go financingfor the remaining 40.9%. Under Paterson's executive budget and five-year financial plan, bond financing would drop to 58.5% of capital in fiscal 2010 and continue on a downward slope, while pay-as-you-go would move on an upward trajectory. In fiscal 2014, pay-as-you-go would hit 51.5% versus 48.5% debt.

"It seems prudent to gradually reduce the state's reliance on the debt markets for critical capital investments, given the uncertainty and continuing turmoil in the municipal bond market," Division of Budget spokesman Jeffrey Gordon said in an e-mail.

One area that would see a big shift to pay-as-you-go financing over the next five years is economic development and housing. "The state would like to reduce its issuances of more expensive taxable debt," Gordon said.

Even with the shift away from debt as a percentage of capital funding, New York's outstanding debt would increase to $59.24 billion in fiscal 2014, a $7.6 billion increase over fiscal 2009. Issuance would rise to $5.63 billion in fiscal 2010 from $4.86 billion in the current fiscal year and then rise again in 2011 to $5.98 billion, before trending downward in fiscal 2012 andreaching$4.37 billion by fiscal 2014.

The Debt Reform Act of 2000 restricted New York's issuance to capital purposes, and, once fully phased in, will limit outstanding debt to 4% of the total annual personal income in the state and debt service to 5% of all funds receipts. In October, the state reported that falling personal income projections would push projected outstanding debt over the limit by $800 million.

"They're not alone," said Standard & Poor's analyst Robin Prunty. "There are a lot of states right now that are bumping up against either self-imposed or statutory debt limitations just because of where revenues are performing. There have been times where they've attempted to use a little more pay-go and obviously that has the advantage of being flexible in down economic periods."

State Comptroller Thomas DiNapoli has long railed against what he has called an overreliance on debt "to permit unsustainable levels of government spending."

"The governor is right to start moving New York to pay-as-you-go for capital projects in order to stay below the state's debt cap," DiNapoli said in a statement. "The hard part is staying the course."

Gordon said that the state was "proactively" managing its debt levels to stay within its statutory cap.

"The state proposed actions in the current budget to reduce its capital spending by funding only essential projects and increase the use of current resources [pay-as-you-go] by $1 billion over the last four years of the plan," Gordon said. "It offers the benefit of reduced debt service costs, of fixed costs, in future years, which facilitates balancing the budget."

Earlier this year, Paterson instituted a review process for all new capital projects by the Division of Budget and the office of state operations with the goal of reducing capital spending. Only projects deemed essential can proceed.

The future impact of this weeding out of capital projects is uncertain and was not included in calculations for future capital spending. Also left out was the economic stimulus package currently under development by the incoming administration of President-elect Barack Obama that could fund infrastructure projects in the state.

The national recession and Wall Street's crash and burn have pushed New York's finances deep into deficit territory, forcing the state to close a $1.7 billion deficit in the current fiscal year and a $13.7 billion deficit in fiscal 2010.

Paterson proposed a series of spending cuts and revenue-boosting actions that have already drawn criticism from special interest groups. A tax on sugary sodas and digital music downloads has raised hackles while cuts to education and Medicaid have drawn opposition.

"There are people who are uncomfortable with this budget who don't realize how uncomfortable they will be with reality," the governor said in a recent conference call with reporters. "If we don't close this budget deficit we will subject the state to poor credit ratings and an inability to borrow, an inability to deliver services. Then we'll have cash-flow problems. Then we'll be on the brink of insolvency.The time to recognize this is now."

Paterson warned that the state faces a potential $36 billion in deficit in fiscal 2011.

"The state is trying to use this somewhat dire situation they're in as a starting point to take the state to a better place fiscally," Rames said. "They're sensing that there might be some opportunity here: If we can convince everyone that things are as bad as they really are, we can get them to make not just the easy decisions but the hard decisions as well, and put the state on a course toward better structural balance and better fiscal health in the future."

Can Paterson pull it off and wean the state off so much debt? He said lawmakers should "bite the bullet" to make 2009 the year that everyone sacrifices and then "try to pull this state's financial package into order." But an executive budget proposal has to get through the Legislature, and a five-year plan has a lot more time to get modified.

"What it ultimately looks like, what is ultimately negotiated is what the key issue is, but clearly there are ... difficult choices to be made in order to restore balance both on the revenue and spending side," Prunty said. "The fact that they're taking a long view is positive."

Matt Fabian, managing director at Municipal Market Advisors, said it was too soon to say where New York would be in fiscal 2014 in regards to its pay-as-you-go versus debt financing.

"Five years, who knows?" Fabian said. "I don't think there's any kind of way we can talk about it - there's way too much in the air right now."

Another question is how the market would react. New York plans to replace its service contract bonds with its more highly rated personal income tax bonds. Gordon, the budget spokesman, said that based on bond sales in November and December, the state saved between 50 to 100 basis points on its PIT bonds compared to its service contract bonds.

Over the course of five years, the issuance of non-transportation related public authority bonds would fall from $4 billion in fiscal 2010 to $3 billion in fiscal 2014, according to the proposed five-year capital program.

"Under normal circumstance New York trades at a premium, so the supply of New York debt has never really outstripped the demand," said Fred Yosca, head of trading at Bank of New York Mellon. "You cut that back dramatically and obviously you'll see a big spread."

If New York debt become too pricey for investors due to scarcity, buying out-of-state debt and paying the taxes could conceivably become a better deal.

"At some point in time, it becomes counterproductive for a New York buyer to pay that much of a premium," he said.

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