Possible federal default spells trouble for states

By Jamey Dunn

As lawmakers in Washington, D.C., struggle to find a compromise over raising the federal debt ceiling, concerns are brewing in Illinois about the state’s investments, credit rating and programs funded by federal dollars.

Republicans in Congress have called for budget reforms and cuts before they will vote to raise the amount the federal government can borrow. The U.S. Treasury Department warned that if Congress does not vote to raise the ceiling, America would default on its debts. President Barack Obama is now looking to the Democrat-controlled U.S. Senate to create a plan that can pass in the Republican-controlled U.S. House. “Today I urge Democrats and Republicans in the Senate to find common ground on a plan that can get support from both parties in the House — a plan that I can sign by Tuesday,” Obama said in televised statement today. “There are plenty of ways out of this mess, but we are almost out of time. We need to reach a compromise by Tuesday, so that our country will have the abilities to pay its bills on time as we always have -- bills that include monthly Social Security checks, veterans benefits and the government contracts we’ve signed with thousands of businesses.”

Obama warned today that too much foot dragging could cause bond rating agencies to lower the country’s credit score, “not because we didn’t have the capacity to pay our bills — we do — but because we didn’t have a AAA [political] system to match our AAA credit rating.”

If the country’s credit rating drops, it could spell trouble for states, where ratings might quickly follow suit. “If for some reason the United States government bond rating is lowered from AAA down, that will absolutely have a splash back on other units of government,” Illinois Treasurer Dan Rutherford said at a Chicago news conference today. “If for some reason the American government’s bond rating is lowered, there is no question in this treasurer’s mind that that will affect Illinois’ bond rating. … So when Illinois looks to go into the marketplace and borrow money, it will be more expensive.”

In recent years, Illinois has struggled to keep its rating from dropping to “junk” status. After lawmakers approved an income tax increase in January, one agency improved the state’s fiscal outlook to “stable”, but two others gave the state a “negative” outlook for the future. “Illinois does not have any immediate plans to issue debt, and the current rates we have are fixed. However, if a compromise is unable to be met, the U.S. could lose its AAA rating for the first time in history. This would likely lead ratings agencies to downgrade every state, which would add hundreds of millions of dollars in interest costs to bonds sold in the future. In Illinois, that would mean money we desperately need to educate our students, ensure public safety and protect our seniors would now be used to pay interest costs,” Kelly Kraft, spokesperson for Gov. Pat Quinn’s budget office, said in a prepared statement.

Experts predict a default could create serious economic upheaval nationwide, which could stall or even turn around any economic recovery made in the state. “All the gurus suggest — and it makes sense — that this is going to put a drag on the economy, this sort of delicate recovery that we’re in,” said Christopher Mooney, a political studies professor with the Institute of Government and Public Affairs at the University of Illinois. Such a decline could also be bad news to a state government, such as Illinois, struggling to find its way out of a record deficit. “You’ve got the two things that happen when the economy goes bad: Revenues go down and service costs go up,” Mooney said.

Rutherford said he is working to ensure that the state’s investments are protected, but safety may come at the expense of potential interest that could be earned. Rutherford said the state earned about $5 million in interest in June. “Risk is not an option. I’m prepared to put the state portfolio that becomes liquid into zero interest accounts,” Rutherford said. He said the money would go into accounts where it would not earn interest but would be protected by the Federal Deposit Insurance Corporation.

Quinn said he is confident that a solution will be reached. However, he is concerned about areas of government that rely heavily on federal support. “We have to worry about public safety first and foremost. … We have 11 nuclear power plants in Illinois — reactors — we have to have inspections of them by the federal government all the time for public safety. So that’s a concern. Our military — we want to make sure our soldiers are paid. They’re on the front line for our democracy in far away places. Here in Illinois, we have our National Guard that we have to deploy from time to time to deal with natural disasters,” Quinn said at a Chicago news conference.

Kraft said the state is working on contingency plans. “We are working with agencies to evaluate the potential impacts in our state that could affect job creation, Medicaid and our infrastructure.” Illinois receives a high rate of matching funds for both the Medicaid program as well as capital construction projects.

Mooney said state officials are probably perplexed about how to handle the situation because no one knows exactly what the ripple effect of a federal default would be on the states. “It’s going to be awful for everybody. This isn’t just Illinois-specific. … It’s totally uncharted territory.”