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Q

I have laddered municipal bonds here in Connecticut and am concerned about my state’s fiscal condition. While they are all “AAA” or “AA” and insured, should I be liquidating and going to states like Maryland or Alabama or Tennessee or Texas, where the per capita debt is very low?  Or does staying in one of the richest per capita states virtually guarantee the taxing power (under duress) of potentially floundering General Obligation bonds?

A

James A. Klotz responds:

As you know, virtually all states have seen revenue drops, leaving budgets unbalanced in face of the worst recession in 50 years. However, states, like Connecticut, have the ability to institute corrective actions to counterbalance hard economic times. As we have reported here in the past, the likelihood of a state defaulting on its debt is extremely remote.

In a recent report on Connecticut, Standard & Poor’s reaffirmed that state’s “AA” rating, commenting that high wealth and income levels, a diversified economy and budgetary flexibility to adjust revenues counterbalance a history of budgetary imbalances and high pension liabilities.

We would not recommend trading out of Connecticut to other states’ obligations for credit risk reasons. Connecticut’s credit profile and ratings represent an average state in terms of credit quality. A “AA”-rated state is expected to easily meet its debt payments in a timely fashion, and we do not foresee the need to change your investments based on Connecticut’s current financial problems, which we believe will be resolved over time as the economy improves.

As far as local government bonds are concerned, we have found that localities normally place a very high priority on paying their debt. Failure to do so would be illegal in most cases since the security pledge they make is legally enforceable. Local governments and their agencies would lose access to the municipal bond market in the future if they were to default on their bonds.

Typically, a community in distress will seek assistance from its state government if it is experiencing payment difficulties. In Connecticut, when Bridgeport was financially stressed several years ago, a financial control board was put in place to ensure that debt was paid and the city’s finances were put in order. As stressful as the current financial difficulties are for local governments, payment of debt service remains a high expenditure priority and this is reflected in the fact that virtually all local government bonds have investment grade ratings. We recently wrote about Standard & Poor’s efforts to raise the debt ratings of local governments to better reflect their strong payment history. We believe those track records will remain intact in the future.