Although the housing market continues its slump and a high rate of default persists in the subprime mortgage industry, state and local government credit quality is not likely to dramatically suffer anytime soon.
That’s the conclusion of recent studies by Standard & Poor’s and Fitch Ratings, which detail the impact of the national housing downturn.
Municipal bondholders should expect possible downgrades in some cases, but defaults are highly unlikely. The chief reason for the lessened impact of housing price declines on credit quality is that market values and assessed values don’t necessarily correspond to each other in many areas.
For example, California and Massachusetts both passed propositions in years past that delinked actual property values from the values used for levying property taxes. California’s Proposition 13 severely limited the rate at which assessed values could grow, regardless of how fast the real estate market grew. As a result, a decline in real estate prices today is unlikely to have a direct, proportionate decline in the assessed valuation used for determining a property tax bill. This serves to cushion the impact of both the rise and fall of home prices on property taxes. In states that lack such mechanisms, the direct relationship between home prices and assessed values would be more pronounced.
Another reason the credit quality of local governments might not suffer along with the housing market is the diversity of revenue sources available to local jurisdictions. While property taxes are a major source of revenue for local governments, other taxes and fees, such as sales tax and fees for service, also fund local government operations. Additionally, a downturn in property taxes can be met by local officials through budget cuts.
Diversified economy also helps
A diversified economy also can counterbalance a weak housing market. Nationally, The Wall Street Journal and other publications report strong employment and other economic indicators, with many analysts pointing to continued economic growth outside of housing. Standard & Poor’s has traditionally looked to the economy as the major predictor of a government’s ability to pay debt service.
For bondholders, the housing slump and subprime mortgage problem can, indeed, cause the credit ratings to decline for some municipalities. But the effect will be far less severe than that experienced in the mortgage sector itself. We believe it is only a remote possibility that actual non-payment of debt service would occur at the local level because of declines in the housing sector. Clearly, some local and state governments will feel the effects more than others. However, as numerous local governmental fiscal crises in the past have illustrated, government has many arrows in its quiver to continue to meet its obligations to deliver services to citizens and pay debt service to bondholders.