Thursday, September 2, 2010

How Does Maine Rate?

It is no secret that states are staggering under the prospects of revenue shortfalls and looming unfunded liabilities. Bondholders concerned about the possibility of default have begun to buy insurance in the form of Credit Default Swaps (CDS), which guarantee the proceeds expected at maturity. The chart above, released Monday by Bespoke Investment Group, displays the "premiums" for such coverage. The number next to each state represents the cost per year to insure $10,000 worth of state bonds for 5 years. The higher the price, the higher the default risk.

So how risky are Maine's bonds? Moody's and Fitch have recent upgraded their ratings of our bonds to AA2 and AA+ respectively, but Standard & Poor's reiterated its
negative outlook three months ago, much to the consternation of State Treasurer David Lemoine, who bemoans the higher cost of borrowing occasioned by the lower rating. In a letter to S&P dated June 9, Lemoine pointed out that "the people of Maine have a one hundred and ninety year history of issuing state general obligation bonds without default, a constitutional mandate to pay bond holders in full before any other state expenditure can occur, and a state government with current revenue expectations at twenty-five times general obligation debt service"--all signs of creditworthiness. But "history" these days quickly becomes ancient. An unprecedented pension liability, exacerbated by an eroding investment portfolio, is not likely to persuade S&P to change its outlook anytime soon.

As for the price of protection, Lemoine professes in an e-mail earlier today to know nothing of "the nature or make-up of a muni CDS market." Having been burned in 2007 for investing nearly $20 million of Maine's Cash Pool (back when we
had a cash pool) in risky derivatives, Lemoine no longer plays with those matches. But even if he himself neither buys nor sells swaps, the suspicion remains that somebody does. Again, at what price?

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