Maryland's cloudy credit horizon

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It would be ironic if Maryland, for the first time in the history of municipal bond ratings, lost its AAA status now. Thanks to a combination of spending restraint, tax increases and other reforms, Maryland's balance sheet is stronger that it has been in more than a decade. Gov. Martin O'Malley's budget proposal leaves nearly $1 billion in various reserve accounts, and the legislature stands poised to change the way it funds employee pensions to make the system more solvent.

But thanks to the dysfunction in Washington, that's just what may happen. Moody's Investors Service, one of the big three bond rating agencies, issued a report this month about which AAA-rated state and local governments would face downgrades if the federal government is downgraded. On the list: Maryland and Virginia, along with Missouri and New Mexico. More that a dozen local governments in Maryland and Northern Virginia are also in line to be whacked, including Montgomery, Prince George's, Harford, Howard and Baltimore counties.

Other publications from Moody's suggest that a federal downgrade isn't necessarily imminent, and the agency hasn't said whether any particular event — like a failure to raise the debt ceiling or to address the sequestration cuts due on March 1 — would trigger action. Rather, Moody's is concerned about the medium and long-term trends in the ratio of federal debt to gross domestic product. "If the upward trend in projected debt ratios and interest costs continues, and further measures to stabilize and ultimately reverse them are not put into place, the rating could eventually move down," Moody's said in a Feb. 8 report.

Moody's has not changed its assessment of the strengths that have prompted it to give Maryland its highest possible rating — a history of responsible fiscal management, a strong economy and a highly skilled work force, among other things. But the agency has a rule that if a "sub-sovereign" entity — i.e., a state or local government — has particularly strong linkage to the sovereign government, its rating cannot exceed the national rating. The agency looks at five factors to determine such linkage, and both Maryland and Virginia are rated as outliers on two of them: federal employment as a percentage of total employment, and federal procurement contracts as a percentage of gross domestic product.

Moody's observation about the linkage between the state's economy and the federal government is bound to become subject to tsk tsking by the Maryland-is-bad-for-business crowd. They are right that the state needs to explore ways to diversify its economy and that, given the likelihood of federal cuts, Maryland can't count on the federal government for economic growth. But it's not like a radical change in the political climate in Annapolis could solve our current predicament. In order to grow its way out of being considered by Moody's to be strongly linked to the federal government, Maryland would need to increase its GDP by 73 percent and its workforce by 77 percent without getting another dime in federal contracts or a single additional federal job.

What would happen if Moody's did downgrade Maryland's bond ratings? That's entirely unclear. Theoretically, it would lead to higher borrowing costs. But neither of the other two major ratings agencies, Standard & Poor's and Fitch, has said it will automatically downgrade any state or local governments based solely on the federal rating. Indeed, S&P did downgrade the federal government after the debt limit standoff of 2011 without taking corresponding action against Maryland. Moreover, S&P's federal downgrade didn't significantly increase borrowing costs, and it's altogether unclear that bond buyers would look at Maryland much differently if it had merely two out of three possible AAA ratings.

In the end, what we're talking about here may be little more than a matter of Maryland pride. Governors like to brag about Maryland's AAA bond rating, and saying we are top-rated as a credit risk by two of the three major agencies doesn't quite have the same cachet as having always been triple-AAA.

Treasurer Nancy K. Kopp has argued Maryland's case to Moody's, to no avail. Rules, it seems, are rules, and it is the arbitrariness that she and other state officials find so frustrating. But there is at least one consolation: Virginia, our rival and political mirror image across the Potomac, is in exactly the same boat.

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