U.S. State Cuts Hit Health Care and Education While Helping Bondholders

Photographer: Chris Goodney/Bloomberg

A student who transferred from Devry Inc. to LaGuardia Community College, sits in an empty classroom at LaGuardia in the Queens borough of New York, U.S. Close

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Photographer: Chris Goodney/Bloomberg

A student who transferred from Devry Inc. to LaGuardia Community College, sits in an empty classroom at LaGuardia in the Queens borough of New York, U.S.

Florida is firing 1,300 workers. New York is cutting education funding and freezing public employee wages for three years. Arizona is slashing Medicaid coverage. And municipal bondholders are having their best year since President George H.W. Bush was in the White House.

Over the past six months, governors and lawmakers balanced their fiscal 2012 budgets and protected their credit ratings on the backs of public employees, school districts, cities and Medicaid recipients, all of whom bore the collective brunt of budget-cutting in states from New Jersey to Wisconsin to California.

While deficit pressure produced deep cuts in services to taxpayers, bondholders who placed their bets on municipal debt reaped the benefits of the market’s best second-quarter performance since 1992, even after analyst Meredith Whitney predicted as many as 100 municipal defaults valued in the “hundreds of billions of dollars.”

States are “making a lot of true cuts,” said Justin Hoogendoorn, managing director of the strategic analytic group at BMO Capital Markets in Chicago. “You’re seeing it in health care, human services, education. There is definitely some pain in those budgets.”

Two Pictures

As the fiscal year began July 1, contrasting portraits of states and the $2.9 trillion municipal market emerged. So far in this calendar year, the number of municipal defaults tracked by the publication Distressed Debt Securities Newsletter -- 25 defaults on $752 million in debt -- is less than that seen in the first half of 2010, which saw 60 defaults on $2.87 billion, said editor Jack Colombo in a phone call from Miami Lakes, Florida.

Investors who guessed that predictions of widespread municipal defaults made at the end of last year were wrong saw their bets pay off in the first half of 2011 as states cut expenses.

“There is some credit pressure, given the circumstances, but not to the degree we’re seeing with sovereign nations across the pond,” said Mark Stockwell, director of municipal research at PNC Advisors in Philadelphia, which has $7 billion in municipal assets under management. “The governors and legislatures are making the tough decisions.”

Bank of America Merrill Lynch’s Municipal Master Index, which measures price changes and interest income, has returned 4.45 percent since March 31. That’s the most since the index of tax-exempts gained 4.47 percent in the same period in 1992, according to data compiled by Bloomberg. Munis outperformed corporate debt and Treasuries in the quarter and in the half- year, according to Merrill indexes.

More Storms

States, many of which have been cutting budgets since 2008, are going into the budget year facing continued economic uncertainty, the loss of federal stimulus dollars and tax collections that remain below prerecession levels. Total general-fund revenue remains 3.6 percent below prerecession highs, even though several states have increased taxes, according to the National Governors Association and the National Association of State Budget Officers.

After recessions in 1991 and 2001, funding for education, health care and other services was restored as the economy recovered. That is no longer assumed.

“It is the big unknown,” Perez said. “The question is whether there will be a shift back.”

Shedding Workers

New Jersey Governor Chris Christie used a line-item veto to cut almost $1 billion from the budget he signed June 30, reducing funding for schools, police and tax credits for the working poor. Hours before Illinois began its fiscal year July 1, Democratic Governor Pat Quinn sliced $376 million from Medicaid and school transportation programs. Illinois has accumulated a $4 billion backlog of unpaid bills to vendors.

At least 17 states have raised retirement costs for public employees while others, including Wisconsin and Ohio, have curbed collective-bargaining rights for most government workers. Other states are following Wisconsin’s lead in targeting unions.

State government employment is down to early 1999 levels, or in terms of employees per 1,000 population, the lowest since 1976, according to a June 13 report from RBC Capital Markets. In May, the state and local government workforce dropped by 30,000, with 17,500 lost jobs coming from the education sector, the report said.

Cutbacks at the state level have directly affected local governments, which are already struggling with prolonged unemployment. Miami had its credit rating cut June 27, as did Cook County, Illinois, which encompasses Chicago, on June 16.

Facing a projected budget deficit of $587 million, Chicago Mayor Rahm Emanuel told city unions June 29 that he will fire 625 workers unless they agree to work-rule changes.

BMO’s Hoogendoorn said cuts are aggravating pressures on local governments feeling the squeeze of declining property tax revenue.

“There’s no question there will be some austerity coming out of the federal government and that’ll hit the states,” Hoogendoorn said. “Even if we do get a bit of a recovery in revenues, I don’t see it going back to peak revenues for some time.”

To contact the reporters on this story: Timothy Jones in Chicago at tjones58@bloomberg.net Romy Varghese in Philadelphia at rvarghese@bloomberg.net

To contact the editor responsible for this story: Mark Tannenbaum at mtannen@bloomberg.net

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