Governments Wonder: Smash the Piggy Bank or Shield It?

By Jonathan Mummolo
Washington Post Staff Writer
Sunday, September 27, 2009

After a hiring freeze, trims of vacant positions and a furlough plan that a federal judge ruled unconstitutional, Prince George's County Executive Jack B. Johnson said Monday that he had "nowhere else to look" to curb government expenses other than to lay off up to 125 county employees.

But there was at least one other option Johnson (D) chose not to employ: using a sliver of the county's $182 million rainy-day fund.

When, and whether, to tap a rainy-day fund is the subject of debate in financially strapped counties and states across the country. To many observers, the worst economic downturn since the Great Depression, as some economists have labeled this one, more than qualifies as a "rainy day."

But others, including Johnson, say that such funds are to be used only for one-time expenditures and that preserving the fund helps maintain the county's standing on Wall Street. He also said that if the financial downpour worsens next year, raiding reserves now could leave the government in a full-blown crisis later on.

"There's one thing that Wall Street will not allow us to do, and that is to use reserves for ongoing operations," Johnson said. "When you use reserves, it should only be for one-time costs -- the cost to build a road, the cost to build a library . . . maybe buy some equipment. . . . [But] you must meet your operational deficit with cuts."

State and local governments have long had contingency funds, but many chose to grow them substantially in the 1990s and early 2000s, experts said, in part because of repeated recessions and unforeseen emergencies. Unlike the federal government, most states and localities are required to pass a balanced budget, so large revenue drops usually force drastic cutbacks or new taxes.

Bill Fox, an economics professor at the University of Tennessee, Knoxville, who has studied rainy-day funds at the state level, said states should maintain about 12 to 14 percent of their operating budgets in reserves to brace for a moderate downturn, while local governments can get by with a bit less.

But judging just when to break open the piggy bank can largely be a guessing game, Fox said. Crack it too soon, and a locality may be broke before the recession has subsided.

"You're effectively guessing, 'How severe is this recession going to be?' " Fox said. "This is an art. It isn't a science."

For some localities, the purpose of having a rainy-day fund is mainly to have one. Financial rating companies such as Standard & Poor's, which give localities bond ratings -- analogous to personal credit scores -- place significant weight on the level of a government's reserves. If a county is forced to dip into its rainy-day fund, Wall Street regards that as a desperate act and could lower the county's rating, experts said, forcing much higher interest payments on borrowed funds in the future.

"It might be rainy now, but you might have a typhoon come springtime," said Jacqueline Byers, research director for the National Association of Counties. Using the fund is "not the thing you do first. You try lots of other things first."

Johnson's position is not unique in Maryland; officials in Montgomery County and the governor's office have also steered clear of the funds when addressing recent shortfalls. Shaun Adamec, a spokesman for Gov. Martin O'Malley (D), seconded Johnson's reasoning, saying losing the state's AAA bond rating would be hugely expensive in the long run.

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