In our opinion this is a short-term shock, although it will likely change some behaviors for the long term that will need to be monitored.
The initial concern is liquidity, not just in the bond market but also at the state level, where tax payment dates have been extended and economically sensitive revenues such as sales taxes, energy taxes, and transportation fees have experienced a sharp drop-off from the coronavirus-induced shutdown. The unprecedented federal response is to address liquidity in the market as well as provide funds to important sectors of the economy such as healthcare and transportation and other aid to municipalities for fighting the virus. Postponed revenues will eventually be received by the states, although not as much as states had originally budgeted.
States have tremendous resources available to them, and numerous states have economies larger than the GDP of some countries. Resources include federal aid revenue sharing, taxing, and fee-raising ability. States also have the flexibility to reduce expenditures. Many states budget conservatively to have flexibility to adjust revenues and expenses throughout the year. Most states have also built up sizable reserves as a reaction to their experience during the financial crisis. I just got off a conference call with Fitch Ratings, whose analysts surveyed states and reported that many are expecting to use internal fund borrowing to finance the delay and shortfall in revenue. They also have tremendous market access and access to their banking partners.
States are not authorized to go bankrupt. States cannot file for Chapter 9 bankruptcy, because they are co-sovereigns with the federal government under the US Constitution (10th Amendment). The State of Arkansas did default on payments during the Depression because of the desperate economy and their overlevered position, but the state eventually repaid the debt.
Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
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