Cash crunch for cities, school districts may worsen

Jasmin Amezcua, 8, attends a protest against education budget cuts in Los Angeles, California May 13, 2011.

MIAMI (Reuters) - Local governments across America are getting spotty relief at best from fiscal pains even as state governments put 2011's budget battles behind them and worrying headlines about state fiscal difficulties dwindle.

"There's a credit risk rotation away from the states and down to local governments," said Gary Pollack, a managing director at Deutsche Bank Private Wealth Management in New York. "And it's just beginning."

America's nearly 90,000 counties, cities, public school districts and other local governments rely heavily on property taxes and aid from state governments to provide essential services, such as fire protection and education.

But the five-year-old U.S. housing downturn is savaging property tax revenues, and state legislators looking to balance their own budgets in a slow national economic recovery are often cutting aid to cities and towns.

Counties typically get just shy of 31 percent of revenues from state governments, cities and towns about 19 percent, and school districts over half, according to U.S. Census data cited in a report by Wells Fargo Securities analyst Natalie Cohen.

And just a few weeks ago, temporary federal aid authorized under the 2009 economic stimulus program came to an end. Those funds had helped local and state governments through the worst of America's Great Recession.

"They'll be running a bit naked for a while," Pollack said.

For investors such as Pollack, who oversees about $6 billion in municipal debt assets, the pressures on local government finances will require more rigorous bond research before buying bonds.

"I don't want a downgrade, or worse," Pollack said, adding that he favors buying mainly general obligation and 'essential services' municipal bonds, as well as debt issued by top universities and some big hospital systems.

(Additional reporting by Chip Barnett in New York; Editing by James Dalgleish)