The S&P downgrade has changed the financial landscape
The recent decision by Standard and Poor's (S&P) to downgrade U.S. bonds is only the latest episode in what has been a dramatic several months for the American financial scene. But while the attention of most observers seems torn between Washington and the stock ticker, much of the real drama is and will be occurring at the level of states, counties and towns.
It was clear earlier in the summer that, while the wrangling over the debt ceiling was going on in the capitol, the price for the eventual deal would be paid on the local level. Any restrictions on how much the federal government can borrow translates directly into a limit on how much is available for the states — both through direct grants for programs like Medicaid, and through programs that provide goods or services that work at the local level.
Nor will the bond market be much of a relief for the state and municipal budget woes. The impact of the S&P downgrade is not yet clear, neither for federal nor local bonds. What is clear is that whatever the rating, as local governments look to increase their borrowing, competitive pressure will drive up the interest rates on the loans. The result, of course, is that less of that money will be available to spend.
Clearly, states and municipalities will need to make some drastic adjustments to their budgets, especially with the deep federal spending cuts to come. It is in that context that the rating change needs to be understood. It may not signal that America's creditworthiness has in fact deteriorated, and it may not herald an increase in interest rates. But it does indicate that the kind of last-minute wrangling that characterized Washington this summer will not be tolerated by the markets. Rather than face a downgrade of their own bond rating, state and local governments should begin the process of restructuring their obligations now, well before they are in crisis.
Often the word "restructure" is used to refer to a process of last resort; something that happens under court supervision when an enterprise, public or private, can no longer pay its debts. But restructuring debt is a strategy in which a healthy business engages as well, when it and its stakeholders want to make sure it remains healthy.
Already, a few state governments have begun "proactive restructuring." Gov. Andrew Cuomo of New York practiced it when he negotiated with the unions to control wage and benefit costs, resulting in a deal remarkable both for its scope and its process. In New Jersey, Gov. Chris Christie and the legislature restructured the benefits for workers and retirees, thus avoiding a potential collapse of one of the most underfunded pension funds in the country.
What we learn from the examples of New York and New Jersey — and from counter-examples of Minnesota, California, and Washington, D.C. — is that a successful restructure requires the participation of as many of the stakeholders as possible. It cannot be done at the last minute, and it requires a sense of shared sacrifice for a shared purpose.
The process is not easy because it involves sacrifice on everyone's part. But the result — a mutually agreed upon and carefully crafted financial plan that prepares the way for future growth — is infinitely preferable to an austerity budget imposed under emergency conditions, which is the alternative.
Those emergency conditions may seem unimaginable to taxpayers and politicians. But the best way to avoid them is to start imagining them now and then begin the work of preventing them.
Deryck Palmer is partner and co-chairman of the Financial Restructuring Department at Cadwalader, Wickersham & Taft, LLP in New York. He can be reached at email@example.com.
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