Connecticut Loses Investors' Faith by Blaming Stocks for Deficitby
Wealthiest U.S. state adjusted revenue estimates three times
State bonds close to widest yield spread since at least 2013
The swings in the stock market are causing headaches for both Connecticut politicians and investors in the state’s bonds.
Connecticut has lowered its estimates for personal income taxes for the current fiscal year three times in the past four months. In November, the Office of Fiscal Analysis reduced its forecast by $189 million, opening up a deficit. In January it was cut by another $75 million. And last month saw the biggest drop yet, with projections slashed by $200 million, creating a $266 million budget hole. Officials blamed last year’s stock-market losses, which will stem the capital-gains revenue that typically floods in through April.
The revisions show how last year’s equity-market turmoil is restraining the wealthiest U.S. state’s rebound from the credit crisis, which wiped out finance-industry jobs that haven’t returned. Despite Democratic Governor Dannel Malloy’s record tax increase in 2011 and a nearly seven-year national economic expansion, Connecticut has built up just $406 million in reserves -- or about 2 percent of projected expenses this year. It has the third-most-underfunded state pension system and $5,491 of debt per resident, the highest in the nation.
“We’re losing confidence in the revenue estimating process, the magnitude of the shortfall is concerning with reduced options, and the underlying socioeconomic trends are also worrisome,” said Paul Mansour, head of municipal research in Hartford, Connecticut, at Conning, which oversees $11 billion in munis. “I’m looking for something good, and it’s hard to find it.”
Connecticut is the wealthiest U.S. state as measured by per-capita income, with towns that’re home to many hedge funds and finance professionals who commute to Manhattan. That makes its tax collections particularly sensitive to market swings as revenue from capital gains falls. Volatility can also shrink the industry’s take-home pay: Wall Street’s average bonus fell 9 percent to $146,200 in 2015, New York State Comptroller Thomas DiNapoli said this week.
Investors in the $3.7 trillion municipal market are demanding additional yield to own the state’s bonds, a sign that the debt is viewed as relatively riskier. They’ve pushed the spread between 10-year Connecticut general obligations and benchmark munis to 0.52 percentage point, data compiled by Bloomberg show. That’s near the widest since at least January 2013, when the data begin.
Federally taxable Connecticut general-obligation bonds due in October 2029 traded Tuesday with the highest volume since July, Bloomberg data show. The 3.6 percent average yield was the highest relative to comparable Treasuries in about a month.
Connecticut officials have offered varying estimates for the magnitude of the shortfall facing the state. Governor Malloy’s Office of Policy and Management last projected a $19.9 million deficit on Feb. 19, while Comptroller Kevin Lembo on March 1 pegged it at $220 million, up from his $7.1 million forecast month earlier. Those are in addition to the estimates from the legislature’s fiscal analysis office.
“Projections are going to vary from one set of numbers to another,” Gian-Carl Casa, a spokesman for the policy office, said in an e-mail. “But what we should all agree on is that this is a new economic reality that requires a different solution. We hope that solution will happen in a bipartisan manner.”
Jobs in finance, insurance, real estate and related fields reached as many as 145,600 in Connecticut in January 2007, before the financial crisis led to year-over-year reductions in almost every month from 2008 to 2014. It now stands at 130,900, or 10 percent lower than the pre-recession peak.
Connecticut has also faced threats from employers to relocate. The state had a public battle last year over new tax increases with General Electric Co., which in January announced it would move its headquarters to Boston from Fairfield.
Though only about 800 of GE’s more than 300,000 employees work at the Fairfield campus, some municipal analysts saw it as a sign that the state was bumping up against limits on its ability to raise revenue from companies. It has the seventh-worst business-tax climate among states, according to a November report from the Tax Foundation.
When it comes to the deficit, “they like to refer back to the stock market, but let’s face it -- the stock market took a small downturn back in the summer,” Themis Klarides, Connecticut’s House Republican leader, said in a telephone interview. “This is about affordability, it’s about lack of businesses and jobs in the state, and what message that sends to investors.”
None of the three largest rating companies have downgraded Connecticut since Moody’s Investors Service dropped the state to Aa3 in January 2012.
Connecticut has shown a willingness to balance its budget by cutting spending or raising taxes, rather than looking for one-time revenue sources, said Emily Raimes, an analyst in New York at Moody’s, which gives the state a stable outlook.
Though Connecticut’s pension system had just 50.4 percent of assets needed to meet obligations as of 2014, worse than all states but Illinois and Kentucky, it’s up from 49.1 percent in 2012. That’s because four years ago, Malloy announced a plan to boost contributions above the required amount to achieve full funding by 2032.
With much of the budget tied to debt service and pensions, the state has dealt with its shortfalls by reducing spending elsewhere, including payments it makes to hospitals.
The perpetual budget cutting belies the recovery that many muni analysts were once expecting, Mansour said. The scenario they had pictured was an economy growing in line with the U.S., allowing the state to restore services and bolster its rainy-day fund. That hasn’t happened.
Credit-rating companies have “been very patient with Connecticut at the AA rating level and giving them the benefit of the doubt,” said Mansour, whose company is looking to trim its holdings in state bonds. “But this seems to indicate clearly that things are actually getting worse.”