Some Improvement in State and Local Finances

State and local governments continue to improve their finances. They are, of course, a long way from financial health, though some are further along that road than others. It will take years, perhaps decades, maybe longer before investors can declare this sector financially sound in any conventional sense of that phrase. But there is improvement nonetheless, despite some inflammatory and misleading headlines, and that should relieve many of the fears people have about investing in the sector.

These governments have improved matters in the same basic way that anyone would dig out of a financial hole. Though their revenues have grown only slowly, largely because of the substandard pace of the economy’s recovery, they have nonetheless kept outlays growth to an even slower pace. Thus, between 2010 and 2013, total receipts in the state and local sector of the economy grew at only a 2.1 percent annual rate, but these governments kept spending growth to an even slower 1.6 percent average annual rate. Mostly they accomplished this through severe restraint on discretionary spending, which only grew at a 1.4 percent annual pace. This more than offset the 2.6 percent growth pace of outlays for social benefits.

The figures are larger for the most recent four quarters, but these governments have nonetheless stuck to the same program. An 11.1 percent surge in transfers from the federal government pushed up receipts 4.4 percent during this recent time. To be sure, these governments succumbed to the temptation to spend much of this extraordinary flow. They pushed up social benefits payments 10.6 percent. But because they only increased their discretionary outlays 2.4 percent during this time, overall outlays still grew at a slower pace than receipts.

These efforts have allowed state and local governments to improve their net savings flows impressively. After accounting for depreciation, these, according to Federal Reserve statistics, averaged an annualized $91.4 billion during the third quarter this year, the most recent period for which data are available. Though this figure is a still only a modest 4.1 percent of total revenue, it is nonetheless a vast 75.1 improvement over the $52.2 billion in net savings averaged in 2010. What is perhaps even more encouraging is that the current rate of net saving from revenues is almost 60 percent above the 2010 rate.

Such improvements, though modest by many standards, have enabled state and local governments to improve their balance sheets. Between 2010, for instance, and the third quarter this year, the most recent period for which data are available, they have increased their holdings of financial assets 4.2 percent and cut their total liabilities of even kind almost a full percent. They have also cut back on their reliance on debt. Between 2010 and this year’s summer quarter, the outstanding volume of municipal debt of any kind had dropped almost 4.5 percent or by just under $132 billion. The outstanding amount of long-term municipal debt had fallen 3.6 percent or $105 billion, while the amount of short-term debt used by these governments has dropped by more than half. Short-term debt today constitutes only 1.3 percent of all municipal debt outstanding, down from 2.1 percent in 2010.

All this improvement, though welcome, is modest compared to the needs of state and local financing that became so apparent in 2009. Still, the picture of improvement should relieve investors of their worst fears concerning this area, if not in every particular, then in general. Meanwhile, the decreasing volume of debt, both the new flows and outstanding amounts, should further enhance the attractiveness of such holdings, especially since municipal yields, at just about every maturity and credit rating, still stand near historic highs next to treasury and corporate debt.

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