Warning on US muni market threat

States need to consider permanent budgetary changes to close ballooning deficits or risk “significant cracks” in the municipal bond market, the lieutenant governor of New York said on Monday.

Richard Ravitch said New York and other states had historically relied on temporary measures to balance budgets in downturns as a bridge to recovery, a strategy that was unsustainable.

“If nothing changes, you will see significant cracks in the $3,000bn [municipal bond] market,” said Mr Ravitch, a long-time fixture in New York public office who served as an adviser to the governor during New York City’s financial crisis in the 1970s. He is now devising a four-year financial plan for New York state.

The US recession has sapped state tax receipts, with revenue falling for four consecutive quarters, says the Nelson A Rockefeller Institute of Government, a research group. That has left states grappling with budget shortfalls projected to reach $350bn in the fiscal years 2010 and 2011, according to the Center on Budget and Policy Priorities.

Yields in the municipal bond market, where state and local governments raise money, have begun to rise amid concerns about the health of local economies. But thanks to federal subsidies and demand from retail investors, they remain near the historical lows reached this autumn.

In October, the Bond Buyer 11-bond GO index, which tracks 20-year bonds with an average rating of Aa1, dropped to 3.69 per cent, which is the lowest since 1967. It has risen to 4.06 per cent but remains below the 10-year average of 4.73 per cent.

Mr Ravitch, speaking at a conference on state finances held by the Rockefeller Institute, warned that in spite of the size of the fiscal problems, “the message has not gotten through”.

New York governor David Paterson late on Monday said that talks to close a deficit of more than $3bn for the fiscal year ended March 31 have ended and he would use his powers to make cuts. Mr Paterson is withholding payments on unspecified local assistance programmes to prevent the state from running out of cash before the end of the fiscal year.

The state may face significant lay-offs as well as cuts to healthcare and education spending, said Mr Ravitch.

During the past 10 years, New York had used $20bn to $24bn of “one shots”, such as borrowings, asset sales, or non-recurring revenue items, to close deficits while spending had risen consistently, said Mr Ravitch. In addition to banking on economic cyclicality rather than long-term measures to close gaps, states have looked to the federal government for help, which they received through the Obama administration’s stimulus package.

Mr Ravitch said additional stimulus was a “dubious proposition”, given what he saw as a shifting political paradigm in the US based on the sharp criticism of the administration’s healthcare reform efforts.

Unlike municipalities, US states cannot use bankruptcy to restructure budgets because they are not eligible under the US bankruptcy code.

“We need to rethink what is most important about what states do,” said Mr Ravitch, including the role that state, federal and local governments play in funding and delivering public services.

“It is going to be impossible to continue to borrow as we and other states have to fund budget gaps.”