The federal government could reach its debt limit of $11.315 trillion as soon as the spring, Congressional Budget Office analysts said yesterday, causing municipal market participants to worry that the Treasury could halt sales of State and Local Government Series securities to muni issuers for advanced refunding escrows.
The analysts made the remarks during a briefing on the outlook for the budget and economy. They warned that the federal budget deficit could reach $1.2 trillion, or 8.3% of gross domestic product this year - a huge increase from the $438 billion they projected earlier in September.
Jeffrey M. Holland, chief of the CBO's projections unit, said the debt limit will definitely be reached by the end of the fiscal year, on Sept. 30. He added that it could be reached in the second half of the fiscal year, which would start in April, depending on the makeup of a stimulus package, how fast troubled assets recovery program funds are distributed, and the ongoing turmoil in the financial system and housing markets.
If Congress does not raise the debt limit beforehand, the Treasury could shut down the State and Local Government Series securities program, which is used by tax-exempt bond issuers when refunding bonds to avoid violating the tax law by having higher investment yields than bond yields. The window for SLGS securities was last closed in September 2007, before Congress raised it to $9.8 trillion. Congress last year raised the limit to $11.315 trillion in its initial bailout legislation. Muni market participants said lawmakers may have to consider raising the debt limit soon.
"My guess is that will probably be part of the big economic stimulus bill," said Linda B. Schakel, partner at Ballard Spahr Andrews & Ingersoll LLP. "If it's as big as they're talking about, they probably will have to increase the debt limit."
Matt Fabian, managing director of Municipal Market Advisors, pointed out that issuers currently are not doing advance refundings because of the credit crunch.
"It was extremely advantageous to do an advanced refunding in 2007. It got progressively worse in 2008," he said. "Refunding conditions have never been worse."
Fabian said $61.6 billion of SLGS sold for the whole calendar year 2008, compared with $118.7 billion sold in 2007 and $156 billion sold in 2005.
He said, pre-refunded bonds could become more attractive if issuers lose access to SLGS securities.
But Schakel and other bond lawyers said it is important that the Treasury's SLGS program stay open.
"We're all hoping that we'll have a muni market back at some point, and then there may indeed be a need for SLGS securities again," she said. Issuers would otherwise have to buy Treasury securities in the open market, heightening competition for them and making them more expensive, she noted.
Edwin G. Oswald, a tax partner at Orrick, Herrington & Sutcliffe LLP, said that it is "kind of a red herring" to take the view that issuers will not be affected if the SLGS program is shut down because few advance refundings are being done.
Meanwhile, the CBO also projected there will be virtually no inflation - only 0.1% based on the consumer price index for all urban consumers - in fiscal 2009, which could stimulate the municipal bond market.
"Inflation is the enemy of bonds, so low inflation - or deflation - should encourage people to buy bonds," Fabian said.
Most states are less worried about inflation than about deficits, according to Schakel. However, municipal issuers may benefit from cost of living remaining steady, she added.
The CBO will revisit its budget and economic outlook for fiscal 2009 to 2019 when it has "any stimulus proposals to analyze," said Robert A. Sunshine, the office's deputy director. While CBO analysts did not speculate on how stimulus measures could affect the economy, he said, "part of the problem is if we give money to people, they won't always spend it," such as if the government offers tax rebates instead of spending.