Federal Stimulus and the Effect on Municipal Market

Note: This post also available as the MainLine Advisory Note, Federal Stimulus Package – It’s Impact on Municipal Bonds , and may be dowloaded (PDF).

Introduction

Current total state budgetary gap estimates range from $200-350 billion.  The American Recovery and Reinvestment Act will provide $222 billion of aid directly to state budgets and will relieve a current municipality fiscal crisis. Without this stimulus package, state credit ratings would currently be under severe downgrade pressures.

 The Federal Government has over time become more involved with the fiscal health of the states. This stimulus package represents one more additional step by the federal government to directly alleviate state and local fiscal financial stress.  In the recent past the federal government has provided aid to fund changes in Medicaid, state assistance from Federal Emergency Management Agency, and fiscal distress brought on by “disastrous” events (911, Hurricane Katrina & Rita). The American Recovery and Reinvestment Act of 2009, goes directly at the heart of supporting state credit ratings for one year.

Background of The American Recovery and Reinvestment Act

 The total value of stimulus/spending package is $787 billion;  the bulk of it appropriated for 2009-10. An amount of $222 billion is directed toward municipal issuers through direct grants or broader tax provisions; nearly $270 billion when broader health provisions are included.  More specifically:

 · $80 billion directed to Medicaid.  Medicaid makes up 20% of total state spending. Aid amount represents a 6.2%increase in federal share of Medicaid costs.

· $54 billion targeted to restore K-12 and higher education cuts that will balance general governmental budgets in the near-term.· $28 million highway infrastructure fund for road projects in the short-term.

· Remainder includes funds for school construction, education credits, recovery zone bonds, “Build America” tax credits.

Effect on Municipal Credit Quality

In the short-term, the stimulus package will help states bridge budget gap issues temporarily, giving states time to make the spending cuts, and/or tax hikes needed, and hope for some economic recovery. Credit quality will stabilize in the short-term.  Municipal sectors that will benefit the most are:

 · Higher Education

· K-12 School Districts

· Non-Profit Hospitals & Health Systems

· Mass Transit

Conclusion

If economic growth does not return by 2010, and the states do not begin planning cuts or additional revenue sources now, stimulus funding will not help credit quality in the long-run.  States depending on this one time boost to balance budgets for 2009-10 will find themselves with a bigger deficit gap tomorrow than they do today. The Federal Government has once again provided the states with funds to support their delivery of essential services for the next year.  States that have shown past fiscal prudence will use this time to get their financial house in order, and should remain solid credits going forward.  Those who do not will be facing credit downgrades, unless economic conditions improve quickly, or additional government aid is provided.

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