LOS ANGELES - Standard & Poor’s attributes much of the above-average creditworthiness of U.S. state governments to the unique countercyclical economic and fiscal support that the federal government offers the states, while warning that such support may be waning.
Following the Great Recession, U.S. states continue to make up one of the most creditworthy sectors, with only six state ratings below AA, the agency said in a recent report.
“A movement away from countercyclical discretionary spending and the real possibility of diminished automatic stabilizers could make recessions a nastier experience for states than they already are,” Standard & Poor’s said. “We believe the sector could be in for a bit more rating turbulence if states are left to bear more of the brunt of national recessions than they have in recent cycles.”
The report compares U.S. states to the 17 nations of the Eurozone, which also participate in a single currency area. While no U.S. state rating fell to below A-minus during or after the Great Recession, seven of the Eurozone sovereign ratings are BBB-plus or lower.
In particular, states benefit from their unique access to “automatic stabilizers” — federal support in the form of nutritional, medical, unemployment, and other assistance programs — that inject spending into state economies without executive or legislative action.
“The stabilizers provide states an unusual degree of flexibility to scale back employment and entitlement costs, particularly for Medicaid, during periods of need like the Great Recession,” said Standard & Poor’s credit analyst and author of the report, Gabriel Petek. “They constitute a significant support for the credit quality of U.S. states, in our view.”
The stabilizers, which mitigate the budget impact of recessions for states, are unique from a global perspective because they serve as a source of broad economic support without encroaching too much on states’ fundamental sovereignty.
“In fact, U.S.-style federalism involves a high degree of fiscal independence for states — latitude that could theoretically allow for widespread mismanagement,” Petek wrote.
As a result, there is a variation in credit quality among the states, but the range in ratings is both tighter and higher than that found in most other sectors.
In addition, the federal aid to state and local governments during economic crises is generally ad hoc, nonentity specific, and political, and, therefore, not something that financial managers can assume will be available. As a result, the hands-off approach has facilitated a more conservative credit culture among states and local governments.
When the government does provide federal support, it is usually aimed at providing macroeconomic stimulus,, like the American Recovery and Reinvestment Act, as opposed to targeting specific states or localities that may be in fiscal distress.
“The arrangement of U.S. fiscal federalism, therefore, encourages fiscal discipline by having state and local governments largely internalize the costs of discretionary fiscal decisions while simultaneously helping soften the fiscal burden to states of economic recessions — which come with nondiscretionary fiscal costs,” the report said.
The possibility that macroeconomic support will recede has risen as a result of a shift of the political discourse in favor of federal fiscal consolidation.
While the ratings agency recognizes that a departure from the existing federal-state relationship is possible, it does not assume that it will occur.
Standard & Poor’s said it believes state ratings will continue to reflect generally high credit quality given that they also operate in a culture that facilitates good credit practices by global standards.