Stimulus plan helped,but spending cuts may hit states -S&P

WASHINGTON, April 29 Mon Apr 29, 2013 9:59am EDT

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WASHINGTON, April 29 (Reuters) - A major cutback in U.S. federal spending could put at risk the credit ratings of states across the nation, Standard & Poor's Rating Service said on Monday.

S&P linked the above-average credit level of U.S. states, of which only six, or 12 percent of the total, have debt ratings below AA, to federal government spending and said cuts in programs such as Medicaid, while unlikely, were a potentially major risk.

"We believe the sector could be in for a bit more rating turbulence if states are left to bear more of the brunt of national recessions than they have in recent cycles," S&P said in a report.

Federal support provided a stabilizing effect on economic conditions and a supportive role in state credit quality, it said, noting that 41 percent of the sovereign credit ratings of euro zone countries were 'BBB+' or lower, and that no U.S. state fell to below 'A-' during or after the 2007-09 recession.

"We attribute much of the state sector's above-average creditworthiness to countercyclical federal fiscal policies that involve reduced federal tax liabilities and large scale outlays during economic downturns," it explained.

"We believe state budget problems would have been significantly worse following the recession were it not for the economic stimulus and fiscal aid to states," said Standard & Poor's.

"By our estimates, the direct aid to states would come to equal about 24 percent of their cumulative budget deficits during the five fiscal years 2009 through 2013," S&P found.

STIMULUS PLAN

Almost since the day it was signed into law in early 2009 the stimulus plan, known as the American Recovery and Reinvestment Act, has been a political piƱata, with policy-makers and commentators alternately beating it as a package of wasteful spending and financial mismanagement.

It sent $140 billion to states in the largest such transfer in U.S. history, mostly through money for the Medicaid health insurance program for the poor and for education, the two largest spending categories for states.

The recession hit state budgets late, with revenue beginning to dive in 2008 as unemployment rose. Because all states except Vermont must end their fiscal years with balanced budgets, they raced to make emergency spending cuts, institute temporary tax and fee increases, and borrow.

They also turned to the federal government for help. The U.S. government now sends state and local governments more than 11 times the money it granted them in 1960, according to President Barack Obama's annual report on the economy to Congress released in March.

For S&P, the ability of states to lean on the federal government in times of stress is a plus, as is the way the aid is distributed. The U.S. government often uses unemployment rates to determine where to provide assistance, so that places experiencing "economic trauma" receive the most support.

"From a global perspective, fiscal federalism in the U.S. has evolved to support relatively high resource allocation efficiency, which, in our experience, is beneficial to credit quality," it said.

In 2011, when the Recovery Act ended, states warned they would fall off a "stimulus cliff," and some slashed spending. That summer, Congress and Obama began a fight over the federal budget that continued through the "fiscal cliff" scare at the end of 2012 and the beginning of automatic spending cuts known as sequestration last month.

Still, 82 percent of the funding state and local governments receive from the federal government is off-limits in sequestration, according to S&P, while the new national healthcare law provides extra money to those states that offer Medicaid coverage to a wider population.

The rating agency does not anticipate a large "paradigm shift" in how the federal government and states interact.

"While we acknowledge that such wholesale changes are possible, our current institutional framework and state ratings distribution do not assume they will occur," it said.

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