Minnesota’s budget showdown could threaten the state’s credit rating

On Monday afternoon, Republican legislative leaders and DFL Gov. Mark Dayton’s top finance officials gathered at the University of Minnesota’s Humphrey Institute to discuss the state’s $5 billion budget deficit. All four officials – House Speaker Kurt Zellers, Senate Majority Leader Amy Koch, Management and Budget Commissioner Jim Schowalter and Revenue Commissioner Myron Frans – expressed optimism about budget negotiations. Asked whether they thought the Legislature would adjourn on time, all four responded with a vigorous “yes.”

But few Capitol observers share their glass-half-full view of the looming budget standoff. Dayton has proposed raising roughly $3 billion in revenue by increasing taxes on the state’s wealthiest 10 percent of residents, while Republicans have vowed to balance the books without any additional revenue. Neither side has given much indication that they’re willing to significantly budge from those fundamentally opposed stances, making a path toward adjournment difficult to discern.

That raises the specter that the budget standoff could drag on into the summer months with the threat of a government shutdown hanging over the proceedings. It also raises fears that the state’s bond rating – which guides interest rates for capital projects across the state – could be at risk of a downgrade.

Minnesota has traditionally enjoyed high marks from the three primary credit rating agencies – Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. Starting in 1997, all three firms gave the state their highest Aaa rating. But in 2003 Moody’s downgraded Minnesota’s bond rating to Aa1, citing concerns about balancing the state’s books through volatile, short-term fixes. The assessments of the three firms have remained fixed ever since.

Agencies weigh multiple factors

Rating firms primarily look at two factors in assessing the risks associated with a state’s ability to meet its bonding obligations: effectiveness of governance and financial management; and economic strength as measured by factors such as unemployment rates and income levels. Lesser weight is also given to tax levels and debt burden in establishing bond ratings.

“The rating agencies do evaluate the management of the state, as well as the political goings-on in the state,” said Jay Kiedrowski, who served as finance commissioner under DFL Gov. Rudy Perpich. “Clearly, if the Legislature and the governor can’t agree and it’s June or July, that’s going to be a negative when the state goes to sell bonds.”

John Gunyou, who was finance commissioner under GOP Gov. Arne Carlson, says the rating agencies will want to see a budget solution that doesn’t merely paper over the state’s chronic deficit problems. In Kentucky, for instance, where bond ratings were recently downgraded by both Fitch and Moody’s, the principal reasons given were increasing pension costs and an overreliance on one-time budget fixes.

“At this point there’s a lot of questions,” said Gunyou, who currently serves as city manager of Minnetonka. “Is the state willing to make the tough decisions that balance the budget and leaves them in reasonable shape for the long term? … Even if it’s bloody and they come out with a reasonable solution, it will reflect well.”

But there’s already significant evidence that the budget proposals being floated by Dayton and the GOP-led Legislature – even if they are somehow ultimately enacted – won’t fix the state’s chronic deficits. The plans put forth by Dayton and the Senate would each create a roughly $1 billion projected deficit for the 2014-15 biennium.  The budget tails for the House proposal are significantly worse, with a $3.5 billion deficit projected for the next two-year budget cycle.

There are also significant questions about the financial assumptions relied on by Republicans in drafting their proposals. For instance, the House and Senate each rely on achieving significant savings – roughly $750 million and $600 million, respectively – by receiving a federal waiver on Medicaid requirements. But officials with the Minnesota Department of Human Services have stated that they don’t believe such a waiver could be granted in sufficient time to create significant savings in the next budget cycle.

“I would not want to be the finance commissioner going to the rating agencies and trying to explain,” Gunyou said of the waiver plan. “The rating agencies will say, ‘When that doesn’t happen, what’s the plan?’”

Ratings downgrade would hit local governments, schools

If Minnesota’s bond rating is downgraded, the implications could reach far beyond the state’s future capital projects. That’s because the rating agencies take into consideration the state’s creditworthiness in assessing the reliability of bonds issued by school districts, municipalities and counties across Minnesota. “The borrowing of every local government unit is affected by the state’s credit rating,” said Charlie Kyte, executive director of the Minnesota Association of School Administrators.

That intersection of state budget troubles and bond ratings for local units of government is already playing out in other states. Earlier this month, Fitch downgraded the rating of the Forest Hills Public Schools district, in Michigan, citing concerns about anticipated future reductions in state aid. And Moody’s issued a report last month warning that Pennsylvania’s public universities could face bond-rating downgrades if proposed 50 percent cuts in state funding are enacted.

Kyte points out that some school districts have already been forced to borrow to meet cash flow needs, in part because of the $1.3 billion K-12 education payment shift that was part of a deal to close the budget hole in 2010. He notes that school districts have been willing to put up with delayed payments in part because they don’t want to see the state run into cash flow problems and jeopardize its bond rating. “The schools felt we were better off being grudgingly cooperative,” Kyte said.

At this point, the shape of the budget endgame remains anyone’s guess. The three proposals currently on the table might not bear any resemblance to the agreement that is ultimately reached by Dayton and the Legislature. But how that plays out over the next six weeks – and potentially beyond – will likely determine if Minnesota’s bond rating is truly at risk.

“At this point everybody‘s just kind of firing warning shots,” Gunyou said. “The biggest thing they’re going to be watching is, did they fix [the structural deficit] or did they just push it off again?”

2 Responses to “Minnesota’s budget showdown could threaten the state’s credit rating”

1. Jim Senter Says:
   April 14th, 2011 at 4:41 am

   Oh yea, let’s mess our britches and fall all over ourselves over the ratings agencies threat to downgrade the state’s bond ratings.

   These are the same guys who gave AAA ratings to securitized subprime ****. They are the guys who shut down Georgia’s municipal bond market by refusing to rate them, when the state had the temerity to pass an anti-predatory lending law in the 1990s. These are the guys who refused to rate any bond if they would be held legally responsible for the accuracy of those ratings just last year. These are the guys who just last week threatened to downgrade the ratings of British banks if the government cut off their bailout committments

   My point is, their judgement of credit-worthiness has proven totally inadequate. The ratings agencies have proven themselves quite willing to use their ratings for political purposes in the past. This is just another example. Screw them and the mangy assed horse they rode in on.

2. Jim Senter Says:
   April 14th, 2011 at 4:51 am

   Why anyone pays any attention to the judgement of these guys, after the history of the last 4 years, is just totally beyond me.

   Oh and I forgot, They downgraded Enron’s AAA rating only AFTER the company announced it was having problems getting anyone to buy its commercial paper. Yep, these are the guys we need to pay attention to….

   Malfeasance. Collusion in fraud. They should be in jail, not dictating public policy.