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Budget fight could hurt Beltway-area local governments

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More than 40 state, county and municipal governments could see their bond ratings downgraded if the coming Congressional fight over the national debt limit results in a stalemate that negatively impacts the federal government’s rating, impacting their borrowing costs at a time when local budgets are already stretched thin.

The governments are so intricately linked to the federal government, for a variety of reasons, that the ratings agency Moody’s believes the local government outlooks can never be higher than the nation as a whole. Moody’s considers the local governments inexorably linked if the jurisdiction includes a large percentage of federal employees, if it gets a large percentage of federal procurement contracts, if health care employment is a high percentage of total employment, or if Medicaid and public hospital expenditures are higher than average costs.

In July, Moody’s revised their rating of the nation’s debt upwards, to Aaa/stable. But that rating could be revised downward again, if the fight over the debt ceiling results in another political stalemate.

Twenty of the 41 governments linked to the federal government’s rating are in Virginia or Maryland, where huge numbers of federal workers live. If Moody’s outlook for the United States turns negative, both states could see their outlooks cut. So could local governments from Alexandria and Arlington to Bowie and Rockville.

If the outlooks are cut, bond ratings could be next. In 2011, at the height of the last debate over the debt ceiling, the ratings agency Standard & Poor’s downgraded its rating of U.S. debt from AAA to AA+, meaning the federal government had to pay higher interest rates on any debt it issued.

“The negative outlook in and of itself is not a problem, but if the bond rating is degraded, it would mean higher debt service costs, and thereby potentially higher taxes, or at a minimum we would have to slow down our capital improvements,” said Corey Stewart (R), chairman of the Prince William County board of supervisors. “All localities across the country are struggling to some extent due to federal inaction and inability to balance the budget. The downgrade of federal debt has had an impact.”

Because of the number of federal workers who live in Prince William, and because of the percentage of the county’s gross domestic product that comes from federal procurement dollars, Moody’s lists it as one of the governments whose outlook would change along with the federal government.

Because most counties and cities budget so conservatively and avoid borrowing for any but the most essential projects, outlook revisions won’t have much of an impact. But counties that have to borrow to finance major infrastructure improvements would find themselves forced to pay higher interest rates.

“It’s really only going to effect those municipalities that need to borrow for large infrastructure projects,” Michael Pagano, Dean of the College of Urban Planning and Public Affairs at the University of Illinois at Chicago, said of the possible downgrades. “They’ll be paying a premium because of their connection to the federal government.”

County and city bonds are seen as much safer to buy than corporate bonds; the default rate among governments rated AAA is much lower than corporate bonds given the same rating, according to Emilia Istrate, the research director at the National Association of Counties.

Many counties, Istrate said, impose restrictions on themselves to make sure their debts don’t spiral out of control. Montgomery County, Md., another government so reliant on the federal government that its outlook would be cut in tandem, requires its debt stay below 1.5 percent of the market value of taxable property; that its debt stays below a certain per capita dollar figure; that the ratio of debt to total personal income stays below 3.5 percent; and that a high percentage of county debt be paid off within a relatively short 10-year window.

“The market taxes any missteps in fiscal stewardship at the local level. If you were not very conservative about your debt, credit agencies will lower the rating of the muni bond issuer and it will cost more in the future,” Istrate said. “The last thing counties want to do is to go to their constituents and ask for more money.”

But even those strict limits, designed to keep Montgomery out of budgetary trouble, can’t convince Moody’s to rate the county higher than the federal government. Tim Firestine, Montgomery’s chief administrative officer, said he argued for the positive outlook the last time Moody’s downgraded their federal outlook, to no avail.

“Moody’s always had this premise that you couldn’t have the sovereign credit, which is the federal government, at a lower rating than the sub-sovereign government,” Firestine said. “We never quite agreed with Moody’s and we told them over and over again.”

The governments in Virginia that Moody’s says are so intertwined with the federal government that their outlooks are threatened include Alexandria City, Arlington County, Fairfax City, Fairfax County, the Fairfax County Water Authority, the town of Herndon, Loudon County, Prince William County, the town of Vienna, Virginia Beach City and the state of Virginia as a whole.

In Maryland, Baltimore County, the city of Bowie, Harford County, Howard County, Montgomery County, Prince George’s County, the city of Rockville, the Washington Suburban Sanitary District and the state of Maryland as a whole have their outlooks pegged to that of the federal government.

Governments far beyond the Beltway could feel the pinch if the debt ceiling debate spirals downward. Concentrations of federal employees in Huntsville, Ala.; Oklahoma City; and Bernalillo County, N.M., mean their local ratings would be slashed. High Medicaid expenditures make the governments of Ames, Iowa; Indianapolis and Hamilton County, Ind.; and the state of Missouri dependent on the federal government for its ratings. And reliance on federal procurement dollars jeopardize positive outlooks for Charleston County, S.C.; Linn County, Iowa; and Bexar County, Tex.

Congress could still avoid any budgetary pain for state, county and local governments by passing a debt ceiling increase and improving economic certainty, experts said. But with so much on the docket at the moment, between possible military involvement in Syria, a stalled immigration reform package and the looming end of the fiscal year, the debate over the debt ceiling is being pushed back. That could cost governments big bucks — or force them to delay infrastructure spending.

“There’s no question that if this continues longer, all local bond ratings will be degraded, and that will mean higher taxes and less capital improvements across the country,” said Stewart, the Prince William supervisor.