Pennsylvania Pays for Political Divide

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HARRISBURG, Pa. – State Auditor General Eugene DePasquale said he got “a snapshot of middle Pennsylvania” from fellow spectators who gave him earfuls about the state budget crisis as he watched his son’s high school baseball scrimmage.

“About 30 people came up to me and not one person said ‘Boy, I hope this side keeps zinging the other side.’ Not one,” DePasquale, a Democrat, said at a Widener University Commonwealth Law School conference. “Here are the words that were used … ‘sad,’ … ‘despicable’ … ‘we should bring pitchforks up there.’ ”

Pennsylvania’s sharp political divide has had heavy ramifications in the capital markets -- five bond rating downgrades in three years -- and the public is increasingly tired of it.

“It comes down to the word compromise,” said DePasquale.

Two weeks ago, Democratic Gov. Tom Wolf, after a year of back-and-forth huffing and puffing with the Republican-controlled legislature, waved a nine-months-late fiscal 2016 budget into law without his signature. The move freed up $6.1 billion, which combined with the partial budget Wolf signed in December, authorized a $29.4 billion plan overall.

It also left only Illinois without an approved 2016 state budget.

Wolf essentially cleared off his plate the 2016 mess and its collateral damage to school districts, which according to DePasquale had to borrow nearly $1 billion in emergency funding. Pennsylvania, though, approaches the new budget with a steep deficit and an escalating public pension liability estimated at up to $63 billion.

Simply put, Day 266 of the budget crisis morphed into Day 1 of a new one. An estimated $2 billion deficit hovers as lawmakers consider Wolf’s proposed a $32.7 billion plan for fiscal 2017, which will start July 1. The sides remain far apart.

“I think the biggest concern is a sense of déjà vu, that they’re starting all over again with the gridlock,” said Tom Schuette, co-head of credit research for Gurtin Fixed Income.

Municipal analysts and rating agencies pounced after Wolf’s announcement.

PNC Capital Markets and Municipal Market Analytics warned of more possible short-term downgrades to Pennsylvania’s credit. Moody’s Investors Service called the adopted 2016 budget “only a brief reprieve.” Standard & Poor’s, while removing the commonwealth’s general obligation bonds from credit watch with negative implications, said the state’s fiscal problems “lie in lack of a political will to solve them in a timely manner.”

Wolf invoked PNC, Moody’s and S&P comments in his own press release titled “Financial Institutions Agree with Gov. Wolf,” while Republicans in their statement accused the governor of a “nine-month political stunt.”

Moody’s rates Pennsylvania GOs Aa3 with a negative outlook. S&P rates them AA-minus and negative, while Fitch assigns an AA-minus rating and stable outlook.

“One thing that bothered me was that there was no commentary that focused on the long-term challenges, notably the pension liability,” said Alan Schankel, a managing director at Janney Capital Markets.

“That’s the big enchilada that the rating agencies are focusing on,” Schankel said. “People are getting disgusted with the politics.”

S&P estimated Pennsylvania’s overall pension funding ratio at a below-average 58%.

Efforts in recent years to overhaul the pension system for state and school employees have merely amounted to bargaining-chip companion bills to budget proposals. Critics say “pension reform” has overemphasized plan-design changes without tackling the underlying funding problem, with some saying the crisis merits a special session in the legislature.

According to Wolf, mandated spending increases account for $1.6 billion of his proposed $32.7 billion budget for fiscal 2017. The increases include $800 million for human services, $500 million for pension obligations, $178 million for corrections and $100 million for debt service.

“Pennsylvania budget increases are on the high side when comparing to other states,” said David Fiorenza, a Villanova School of Business professor and former chief financial officer of Radnor Township, Pa. “Pennsylvania should focus on increasing the budget incrementally over four years and not look for increases in one fiscal year.”

Beyond the capital markets, state and local politics in Pennsylvania have become tabloid fodder.

Montgomery County in August indicted Attorney General Kathleen Kane – the “it girl” of state politics right after her election in 2012 – accusing her of leaking secret grand jury information and lying about it. The state Supreme Court suspended her law license. Kane, who disputes the charges, has in turn linked several judges and prosecutors to a string of pornographic and racially tinged emails.

State Treasurer Rob McCord resigned in January 2015 and pleaded guilty to two federal counts of attempted extortion. And former Harrisburg mayor Stephen Reed faces 17 criminal charges consisting of nearly 500 counts after his arrest last July alleging personal use of municipal bond proceeds during his 28 years in office, during which the capital city's finances plummeted toward insolvency.

“The attorney general scandals harm potential business from relocating in the state as corporations look at a state's tax friendliness but also political stability,” said Fiorenza.

Most visible on watchdogs’ radars are the state’s projected $2 billion structural imbalance, uncertainty about funding for school districts beyond June, and whether the commonwealth can shore up its pension underfunding. The 2016 plan, according to Moody’s, relies on nearly $1 billion of one-time measures, or stop-gaps, and includes no pension contribution at the full actuarially required level, which Pennsylvania has not done since 2004.

“In a bigger-picture view, the problems Pennsylvania faces are manageable. The question is whether there’s willingness as opposed to ability,” said Schuette. “With Illinois, we’re getting into the question of whether they can pull it out. In Pennsylvania, there’s still time for the state to make wise governing decisions.”

Former Michigan Treasurer Andy Dillion, a Democrat, recalled the fallout when Michigan briefly shut down its government in 2007 and 2009. Democrats at the time controlled the governor’s office and the House, while Republicans controlled the Senate.

“The media just skewered us,” said Dillon, who ran unsuccessfully for governor in 2010 and is now an executive director with turnaround firm Conway MacKenzie Inc. “We were called baby-killers for shutting down the government for 24 hours.”

Schankel said this year’s Pennsylvania’s budget battle might not last as long.

“I do think, and maybe I’m overly optimistic, that both sides will be more careful this time not to get trapped in their intractable arguments.”

Pennsylvania is not alone, according to Municipal Market Analytics.

“Pennsylvania school districts, Illinois public universities and Chicago credits, New Jersey’s Atlantic City [and by extension other distressed localities in the state] are weaker today as a direct result of their parent governments,” the firm said in a commentary.

MMA researchers, however, added that Pennsylvania’s school districts may present a buying opportunity in the wake of damage done to the commonwealth’s school district enhancement programs.

“This was a timely concern, not an ultimate payment problem,” they said. “Investors able to endure the odd, temporarily-missed coupon or principal payment should thus find better income available in now lower-rated Pennsylvania school districts.”

DePasquale, a Pittsburgh native and former state representative elected auditor in 2012, said the finalized 2016 budget would help jump-start efforts to improve local pension underfunding. He chaired a Wolf-appointed task force on the subject last year.

“We do know that both parties in the legislature and the governor’s office have reviewed our recommendations and there is a lot of interest,” he said in an interview. “They think there are things that can really happen legislatively to improve the situation, but the budget stalemate was holding it up.”

Recommendations included increasing penalties for municipalities that do not pay their full minimum municipal obligation, requiring municipalities to disclose pension liability and requiring the public posting of municipal pension costs.

DePasquale cited Pittsburgh, which built out education and health-care – “eds and meds” – to rebrand itself from its beaten-down steel days, as a statewide model for turning itself around economically.

“The city of Pittsburgh today is really taking off. The University of Pittsburgh, Carnegie-Mellon, Duquesne, Point Park, Robert Morris – I’m just naming a few – are doing great. Pittsburgh is really attracting a lot of young people there. Philadelphia suburbs are really attracting young people. The same with the Lehigh Valley.

“Look, the number-one thing we need to do is to get public education right in Pennsylvania and certainly increase the number of job opportunities. If we do those two, the amenities we have will help the state take care of itself.”

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