The Downgrade: Perhaps A Yawn But We’re Not Alone

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Since the end of the Great Recession in 2009, economic indicators have been largely positive. The U.S. GDP in 2015 reached $16.3 trillion, finally surpassing the $16 trillion before the recession. U.S. unemployment has fallen to 4.3%, down from 10% at  the height of the recession. Yet despite the recent growth, 13 states including Massachusetts have seen bond rating downgrades from at least one rating agency in the past two years. Five states have suffered downgrades from all three. Their stories should serve as a warning to Massachusetts not to follow in their footsteps.

Bond ratings measure the risk that an entity will be unable to pay back its bond holders. As bonds get riskier, bond issuers are forced to pay higher interest rates to compensate investors for additional risk. Moody’s and Standard and Poor’s rate bonds on a scale from AAA (almost guaranteed) to D (currently in default). Anything below BBB- is considered to be junk and a risky investment. Luckily, Massachusetts has not seen an increase in their interest rate following the downgrade. However, if more downgrades were to come, it is likely that it would pay a higher interest rate.

States bond rating downgrades Jan 2016 to June 2017
Alaska S&P Moody’s Fitch
Connecticut S&P Moody’s Fitch
Illinois S&P Moody’s Fitch
Louisiana S&P Moody’s Fitch
West Virginia S&P Moody’s Fitch
New Jersey S&P Moody’s
New Mexico S&P Moody’s
Kansas S&P
Kentucky S&P
Massachusetts S&P
North Dakota S&P
Oklahoma S&P
Mississippi Fitch


Alaska and the energy producers

There is an old saying: “Don’t put all your eggs in one basket.” Unfortunately, Alaska must not have been listening. Alaska has no sales tax, and won’t begin collecting any personal income tax until 2019. In 2012, as much as 75% of Alaska’s tax revenue came from a severance tax on oil. When oil prices plummeted in 2014, so too did Alaska’s finances. In 2017, Alaska faces a $2.5 billion deficit on a budget of $8.8 billion, which comes out to a deficit of 28%. To cover this deficit, Alaska has been rapidly depleting its reserve fund while scrambling to find alternative revenue sources, both of which are cited in Standard and Poor’s decision to downgrade Alaska’s bonds. Louisiana, West Virginia, New Mexico, and other states with economies heavily dependent on the energy industry suffered downgrades for the same reason. Luckily, residents of Massachusetts need not fear as the Commonwealth has a diverse economy and is not vulnerable to price fluctuations in any one commodity market.


In their report, Moody’s cites the “pending elimination of its rainy day fund, growing budget gaps, and rising debt levels” as reasons for Connecticut’s downgrade. During an economic downturn, tax revenues fall while the need for social services increases. The combination of reduced tax revenue and increased spending often causes states to run a deficit. Without a rainy day fund to cover the deficit, states are forced to either issue debt or drastically decrease expenditures, both of which have drastic long-term consequences.

During periods of economic growth, states should build up their reserves. But despite growth in recent years, according to Reuters, Connecticut plans to empty its rainy day fund to cover unexpected budget shortfalls this year. Rather than using its rainy day fund as a tool to soften the adverse impact of a recession on the lives of its citizens, Connecticut is using it to support an unsustainable budget. Not only is Connecticut leaving itself vulnerable to a potential recession, but it is continuing to spend $330 million more than it takes in as revenue. While Connecticut may have been able to get away with this for the last few years, next year it will have no money left in its rainy day fund. If lawmakers cannot find a way to make drastic cuts to the budget, they will be forced to issue bonds, bringing the state one step closer to a fiscal disaster.

A diminished rainy day fund was one of two major reasons for the Commonwealth’s downgrade cited in a Standard and Poor’s report. While Massachusetts, unlike Connecticut, has not completely drained its rainy day fund, its contributions are far too small. The 2017 budget only contributes $11.3 million, a rate at which it will take about 230 years before Massachusetts is ready to weather even an average sized recession according to the Mercatus Institute. Massachusetts must make consistently larger appropriations to the fund in the next few years if it wishes to avoid a future credit downgrade and protect itself against a potential recession.


Illinois may already be stuck in an unavoidable death spiral. In June 2017, Standard and Poor’s and Moody’s both downgraded Illinois general obligation bonds to BBB-, just 1 step above junk status. In their reports, the agencies cited political gridlock and the unprecedented 40% of Illinois’ operating budget dedicated to servicing debt and prior obligations as reasons for the downgrade.

In 1995, in an attempt to ensure fiscal responsibility, Illinois mandated a certain sum of money each year be allocated to pay off unfunded liabilities in their underfunded pension system. However, beginning in 2003, politicians, unwilling to either raise taxes or cut spending, paid off pension debt by issuing bonds. Essentially, Illinois took out a loan to make the monthly payments on a loan it already had. Since 2003, Illinois has been issuing debt to pay short-term obligations without any significant structural reform, ballooning their debt over time. This year, according to CNN, Illinois faces $15 billion in unpaid bills and $250 billion in unfunded pension liabilities. These numbers continue to climb.

With 40% of their operating budget going to service debt and pay post-employment benefits, Illinois only has 60% of their budget to work with. To move itself out of the red Illinois needs to somehow find ways to cut even more from the remaining 60% of the operating budget. This has proven to be a political impossibility. Illinois has not passed a budget in three years. Yet the longer politicians wait to pass serious budgetary reforms, the worse the problem becomes. In 2003, Illinois legislators elected to kick the can down the road rather than hammer out a sustainable solution. Now, a sustainable solution may be unreachable.

The Standard and Poor’s report also cites debt and liabilities as the other major reason for Massachusetts’ downgrade. Massachusetts currently spends 12.2% of its operating budget on servicing debt and paying for pensions and other post-employment benefits. While this number is significantly lower than the 40% that Illinois pays, it is expected to increase in the future. Unlike Illinois, which let its pension debt expand to one quarter of a trillion dollars, Massachusetts does have a robust plan to pay down its unfunded pension liabilities by 2039. However, it is critical that the Commonwealth pay off their obligations using long-term, sustainable solutions rather than with politically easy cash injections that could lead to fiscal disaster in the long-run.


Connecticut and Illinois are in serious trouble, and they will be very hard-pressed to find a way out of their current situations. Massachusetts however sits at a crossroads. Standard and Poor’s has fired a warning shot, warning Massachusetts not to follow the path of Connecticut and Illinois. It must responsibly bring down its debt, relying on long-term debt reduction solutions rather than bond issuances to cover short-term expenses. It must increase its contribution to its rainy day fund, ensuring that the next recession does not undo all of the progress the state has made towards fiscal solvency.

Joshua Beck is a Roger Perry transparency intern studying computer science and economics at Brown University