States with high numbers of federal workers or contractors, large military
presences or generous Medicaid programs for the needy are among the most
vulnerable from Standard & Poor’s recent downgrade of U.S. government debt.
Last week’s action by S&P is expected to accelerate congressional action to
make deep spending cuts, which could affect those states the most and put
their long-term finances on shaky ground. In a debt rating domino effect,
states such as Virginia, Maryland, California, New Mexico or Illinois could
be at risk of having their own ratings downgraded, even as great uncertainty
persists about the long-term consequences.
"The more a state appears to be tied to federal funds or federal presence,
probably the more concerned the rating agencies will be with its future
because it’s so linked to federal money,” said Michael Bird, federal affairs
counsel for the National Conference of State Legislatures.
Virginia, with its large population of federal employees, and California,
with its heavy reliance on federal reimbursement for Medicaid, have been
mentioned by some experts as states that could feel the ill effects of the
Even so, uncertainty reigns. It’s simply unclear how the S&P action will
trickle down to the states.
California state Treasurer Bill Lockyer, for example, issued a statement
Monday saying there’s no reason to expect that the federal ratings downgrade
will have an immediate effect on California. He warned that the state needs
to be more concerned with repairing its long-term budget problems.
“Since the downgrade seems to be more a statement about the federal
government’s partisan political gridlock in solving its long-term deficit
than about the nation’s ability to pay its debts, California needs to be
more immediately concerned about the continuing effects of the economic
recession on jobs and the stock market,” Lockyer said.
Last month, S&P revised California’s long-term ratings outlook, improving it
from negative to stable. California shares the lowest credit rating in the
nation with Illinois.
Scott Pattison, executive director of the National Association of State
Budget Officers, said he had been talking with state financial officers
throughout the day Monday and there was no consensus about how the S&P
action would affect states.
A state’s reliance on federal assistance “would be a factor to consider” for
a rating agency, but Pattison said some states might be able to offset those
concerns by showing they have a strong rainy day fund or have been willing
to make spending cuts to keep their budgets in line with dwindling tax
“The downgrade is certainly not good news. But on the other hand, we’re
really uncertain at this moment as to the direct effect, whether it will
have a direct effect or not,” Pattison said. “I think it’s going to be a
Standard & Poor’s announced late Friday that it was reducing its credit
rating for long-term U.S. government debt by one notch, from AAA, the
highest rating, to AA-plus. The credit rating agency said it downgraded U.S.
debt for the first time in history because it lacks confidence that
political leaders will make the choices needed to avert a long-term fiscal
Officials at the rating agency were expected to indicate how local and state
governments will be affected by their decision to lower the rating for
long-term U.S. debt. The other two major rating agencies, Moody’s and Fitch,
have not taken a similar step.
If the ratings for states also are downgraded, that could lead to higher
borrowing costs for those states, many of which have struggled to balance
their budgets amid falling revenue, job losses and a slow economy. Some
states could reduce their borrowing, put it off until the economy improves
or borrow directly from banks with which they already have a financial
relationship, to avoid selling bonds on the open market and paying higher
States that have retained the coveted AAA rating, which lowers their
borrowing costs, are among those most nervous about the potential fallout.
New Mexico finance officials have had several meetings with Moody’s over the
past few weeks to justify the state’s top rating. They have noted that the
state has strong cash reserves and adequate property tax revenue, which
supports general obligation bonds.
Virginia Finance Secretary Ric Brown said S&P and the two other major bond
rating services recently affirmed his state’s AAA rating. But the state
remains on “negative outlook” because its economy is so intertwined with the
“The question is if the federal government goes down, then does it suck us
down with it,” Brown told The Associated Press over the weekend.
Another AAA-rated state, Tennessee, is sending a delegation to New York
later this week to meet with officials at Moody’s and Fitch. Finance
Commissioner Mark Emkes said he wants to let the agencies know what steps
the state has taken to remain in the black before they consider any changes
to the state’s rating.
“It would not have a major impact to our finances,” he said of any potential
future downgrade from AAA. “However, it’s a prestigious thing, and we would
like to hang on to it if at all possible.”
S&P analyst Gabriel Petek said one strength of state and local governments
is that while they receive federal aid, they are autonomous from the federal
government. But he said the long-term concern is the pressure to reduce
federal spending, which could intensify with the S&P downgrade.
Nicholas Johnson, vice president for state fiscal policy at the Center for
Budget and Policy Priorities, said, the looming cuts ultimately could have
an effect on states’ bond ratings because the agencies are going to try to
determine whether states governments can absorb the loss the federal money
and take on the burden of providing those services.
One area of concern is health care programs.
California, for example, relies heavily on federal support for Medicaid, the
state-federal health care program for the poor and disabled. The state’s
version is known as Medi-Cal and covers 7.5 million people in a state with a
population of about 37 million.
California will spend about $15 billion of its own money on the program but
is anticipating nearly $30 billion over the next year from the federal
“That,” Petek said, “certainly seems like an area where there’s
Last month, Moody’s Investors Services threatened to downgrade the AAA
rankings of South Carolina, Maryland, New Mexico, Tennessee and Virginia,
noting they have a combined $24 billion in outstanding debt.
If the U.S. lost its AAA rating, Moody’s said, those states are most
vulnerable to being dragged down because of their reliance on federal money.
In South Carolina, for example, one in five residents receives Medicaid
Moody’s said it will be reviewing the states’ credit over the next few
Maryland state Sen. David Brinkley, a Republican, said the federal rating
downgrade was a message to national and state lawmakers that they have to
get spending under control.
“It’s not the end of the world,” he said. “But I think it is a wake-up call
that the current pattern is unsustainable.”