Fed's Interest Rate Cuts Add To Counties' Budget Strain

By Bill Turque
Washington Post Staff Writer
Monday, February 25, 2008

Local governments in the Washington region, coping with a budget crunch driven by declining property tax revenues in a moribund housing market, are facing another financial drain -- this one caused by the Federal Reserve.

The Fed's recent cuts in interest rates, intended to stimulate the economy, have sharply reduced the income that localities receive from investments. The decline has worsened an already bleak outlook for some communities facing budget shortfalls.

Fairfax County officials, who will propose a budget today for the fiscal year that begins July 1, are projecting a $26 million loss in interest income. It means that the gap the county must fill to keep its budget in balance, estimated in December at $220 million, is now at least $246 million. Anticipated cuts in state aid will probably drive the shortfall beyond the quarter-billion-dollar mark.

The effect of the Fed's rate cuts is rippling through other budgets. The District, which had been earning about $70 million annually from short-term investments, projects a decrease of $25 million to $30 million for fiscal 2009. Montgomery County is looking at an estimated $17 million drop. Arlington County's chief financial officer, Mark Schwartz, said the decrease will be "at least north of $3.5 million."

There is good news that comes with the receding rates. Some communities are paying less for the money they borrow to finance capital improvements and other needs. But that doesn't necessarily offset the reduction in investment income.

"We'll get back roughly half of what we lose on investments," said District Treasurer Lasana K. Mack.

Local governments keep most of the money they collect from taxes, bond sales and fees in short-term investments such as Treasury bills, certificates of deposit and "commercial paper," or debt issued by private corporations. Fairfax County, for example, has a portion of its $2.9 billion portfolio invested in such companies as Toyota Motor, American Express, General Electric Capital and Archer Daniels Midland, all with debt that has received relatively high ratings from Wall Street agencies.

A year ago, Fairfax was earning about 5.3 percent on its money, said deputy county executive Edward L. Long Jr., generating an estimated $92 million. That return is down to about 2.7 percent.

The Fed has cut rates five times since September. Most significant for local governments has been the drop in the federal funds rate -- the interest at which banks lend each other money -- which was slashed from 4.75 to 3 percent. Two of the cuts came late last month, just as many communities were completing work on new budgets.

Fairfax had already sent its proposed 2009 spending plan to the printers when the January reductions were announced, pushing the projected loss of interest income to $26 million. Officials said they are concerned about the possibility of continued rate cuts that will deepen the projected shortfall. There is widespread speculation that the Fed will approve another reduction at its meeting next month.

"Good news for consumers, bad news for governments," said Board of Supervisors Chairman Gerald E. Connolly.

Other jurisdictions said the rate fluctuations were less of a factor in their cash management. Prince William County officials said their portfolio is structured mainly around long-term investments with fixed rates. Loudoun County budget officer Ari Sky said the county doesn't place too much weight on expected interest income. "We've been pretty conservative in how we estimate," he said, adding that Fairfax appeared to be "budgeting quite aggressively" in projecting its interest income.

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