"Federalism is Still Alive"

Sydney M. Williams

Thought of the Day

“Federalism is Still Alive”

April 21, 2011

The Republican’s sweep in last November’s election will have a long term affect. They now control twenty-six state legislatures – with the most seats since 1928 – versus fifteen legislatures for the Democrats. (Eight are split and one – Nebraska – is nonpartisan.) In Minnesota, they won the Senate for the first time ever. In Alabama, they took control of both Houses for the first time since reconstruction.

The importance of controlling the legislatures at this time is because of every-ten-year redistricting – a process based on the census and required by the Constitution. The census determines which states pick up Congressional seats and which lose them. Redistricting falls to the state legislatures. The election of Republicans and financially responsible Democratic governors and state legislatures has also brought into office a group that is more fiscally conservative. Well publicized state deficits in Wisconsin and Ohio, for example, have created monumental battles between deficit hawks and union leaders. These states are following the lead established by governors elected earlier, like Mitch Daniels (Indiana) and Chris Christie (New Jersey.) Even newly elected, traditionally liberal Democrats, like Andrew Cuomo (New York) and Jerry Brown (California) are acting, for now, as fiscally responsible governors.

Meredith Whitney, famous for predicting, in November 2007, Citigroup’s dividend cut, forecast during a “Sixty Minutes” segment last December that there would be up to “50-100 sizeable defaults in the municipal bond market.” Her statements accelerated a trend in withdrawals from muni-bond funds – $14 billion came out between December 22 and February 2 of this year. (To put that number in perspective, only $47.3 billion municipal bonds were issued during the first quarter.)

States continue under enormous pressure, driven by unfunded pension and healthcare plans. Public employee unions are fighting for survival. Depressed housing prices, high unemployment and a still-struggling economy have limited tax collections. Ms. Whitney may be proven correct, but two factors appear to be working against her call. The first is that most states must comply with some form of a balanced budget. The second is that municipal bond issuance is running at the lowest rate in eleven years.

According to the National Conference of State Legislatures, forty-four states require that the governor submit a balanced budget, forty-one require that their legislatures pass a balanced budget and thirty-eight preclude the ability to carry a deficit from one year into the next. Every state in the union, with the exception of Vermont, falls into one or more of those three categories. Thirty states (including California!) must adhere to all three requirements. Budget battles have provided grist for the press mills. Governor Scott Walker of Wisconsin has become a lightening rod for public union dissension – deflecting attention from the outspoken governor of New Jersey, Chris Christie. Wisconsin’s constitution requires the governor to submit a balanced budget and requires the legislature to pass one, as does New Jersey’s.

The second point is the dramatic drop in municipal bond issuance. According to the Securities Industry and Financial Markets Association (SIFMA), municipal bond issuance this year ($47.3 in the first quarter) is at an eleven year low, running at 11% of the annual rate for 2010. Unlike the federal government, states cannot print money and most are required by law to operate balanced budgets, unlike their profligate cousins in Washington. The fourth quarter of last year saw record issuance ($133.6 billion), in part because the Build America Bond program was coming to an end. However, the decline in issuance is more fundamental. Yesterday, Michael Corkery and Jeanette Neumann writing in the Wall Street Journal quoted Thomas Doe of Municipal Market Advisors: “the decline in issuance is a reflection of states managing through a crisis in a very prudent way.” CNNMoney, on March 21, quoted Ebby Gerry head of municipal fixed income at UBS: “The new political atmosphere that has emerged in the wake of the November elections has contributed to the decline in muni issuance.”

Reflecting this slow return to fiscal sanity on the part of state governments, the municipal bond market has recovered from its January lows. As a proxy for the market, the iShares S&P National Municipal Bond Fund (MUB) has bounced back from a January low of 96.26 to 100.80 yesterday.

Renewed confidence on the part of state governors and legislatures was manifested this week when Arizona’s legislature approved a measure to permit out-of-state insurers to sell health policies to small group and individual policy holders in Arizona, an obvious way to lower costs by increasing competition. It remains to be seen if Governor Brewer will sign the measure and whether the Obama administration will take legal action against its implementation. But the bill is sensible and long overdue.

The path the states are blazing is one visible to the federal government and one we all should hope they note. The state’s actions reflect a hopeful sign that the increasing concentration of power in Washington is being challenged by rejuvenated states and that the concept of federalism and state’s rights lives on.