From Motor City to Fresno, Credit Ratings Being Slashed

The Congressional Budget Office (CBO) expects the U.S. federal government to have a lower budget deficit this year than those of the previous four years—finally getting the annual deficit under $1.0 trillion (although, not by much). But I am skeptical when it comes to the CBO estimates, as financial conditions at the more local level paint anything but a rosy picture.

Our country has already faced one credit rating downgrade and chances are another one is in the making. Why? Cities across the U.S. are in deep trouble, as their massive deficits continue to increase.

Take Detroit, for example. The city is on the verge of bankruptcy again due to the severe downturn in the local economy and the city’s annual deficit. Detroit’s residents are fleeing the city, with the population down 30% since 1990. (Source: Reuters, January 28, 2013.)

Troubles in California persist. Multiple cities in the state have already filed for bankruptcy; others may also follow suit. Fresno, the fifth-largest city in the state, is in financial stress. Fresno’s credit rating has already been downgraded by Moody’s. The credit rating agency notes that the city already has a high deficit, high payrolls, and other fixed costs in the background of a deteriorating economy. (Source: The Sacramento Bee, February 11, 2013.)

Sadly, this doesn’t just end here. Moody’s downgraded 11 municipalities in the U.S. from stable to negative—and all these cities had a credit rating of “AAA” prior to the downgrade. (Source: Barron’s, February 6, 2013.)

It would be good to finally see the federal government get its annual deficit under $1.0 trillion, but issues with cities are going to increase the U.S. debt. How? As cities run deeper deficits and are unable to pay for their expenses, they will need help. Municipalities will eventually run toward the state governments for a bailout, and the states will seek help from the federal government for more money. Once states require more money, the federal government will see its annual deficit increase, and the U.S. debt will become a bigger issue.

Dear reader, as American cities continue to post deeper deficits and get their credit ratings cut, the outcomes will be harsh on municipal bonds. Keep in mind, a deeper deficit means more borrowing. Until the cities get in better financial shape (which could take until the end of this decade), the U.S. national debt rising substantially higher than predicted remains a real risk.

What He Said:

“There is no mixed signal about this: Foreclosures in the U.S. will continue to rise, the real estate market will get weaker, and the U.S. economy will get weaker. Smart investors should seriously consider unloading their stocks of consumer-products companies that produce nonessential goods.” Michael Lombardi in Profit Confidential, March 12, 2007. According to the Dow Jones Retail Index, retail stocks fell 42% from the spring of 2007 through November 2008.