States with high numbers of federal workers or contractors, large military presences or generous Medicaid programs for the needy are among the most vulnerable from Standard & Poor's recent downgrade of U.S. government debt.
Last week's action by S&P is expected to accelerate congressional action to make deep spending cuts, which could affect those states the most and put their long-term finances on shaky ground. In a debt rating domino effect, states such as Virginia, Maryland, California, New Mexico or Illinois could be at risk of having their own ratings downgraded, even as great uncertainty persists about the long-term consequences.
"The more a state appears to be tied to federal funds or federal presence, probably the more concerned the rating agencies will be with its future because it's so linked to federal money," said Michael Bird, federal affairs counsel for the National Conference of State Legislatures.
Virginia, with its large population of federal employees, and California, with its heavy reliance on federal reimbursement for Medicaid, have been mentioned by some experts as states that could feel the ill effects of the federal downgrade.
Even so, uncertainty reigns. It's simply unclear how the S&P action will trickle down to the states.
California state Treasurer Bill Lockyer, for example, issued a statement Monday saying there's no reason to expect that the federal ratings downgrade will have an immediate effect on California. He warned that the state needs to be more concerned with repairing its long-term budget problems.
"Since the downgrade seems to be more a statement about the federal government's partisan political gridlock in solving its long-term deficit than about the nation's ability to pay its debts, California needs to be more immediately concerned about the continuing effects of the economic recession on jobs and the stock market," Lockyer said.
Last month, S&P revised California's long-term ratings outlook, improving it from negative to stable. California shares the lowest credit rating in the nation with Illinois.
Scott Pattison, executive director of the National Association of State Budget Officers, said he had been talking with state financial officers throughout the day Monday and there was no consensus about how the S&P action would affect states.
A state's reliance on federal assistance "would be a factor to consider" for a rating agency, but Pattison said some states might be able to offset those concerns by showing they have a strong rainy day fund or have been willing to make spending cuts to keep their budgets in line with dwindling tax revenue.
"The downgrade is certainly not good news. But on the other hand, we're really uncertain at this moment as to the direct effect, whether it will have a direct effect or not," Pattison said. "I think it's going to be a case-by-case basis."
Standard & Poor's announced late Friday that it was reducing its credit rating for long-term U.S. government debt by one notch, from AAA, the highest rating, to AA-plus. The credit rating agency said it downgraded U.S. debt for the first time in history because it lacks confidence that political leaders will make the choices needed to avert a long-term fiscal crisis.
Officials at the rating agency were expected to indicate how local and state governments will be affected by their decision to lower the rating for long-term U.S. debt. The other two major rating agencies, Moody's and Fitch, have not taken a similar step.
If the ratings for states also are downgraded, that could lead to higher borrowing costs for those states, many of which have struggled to balance their budgets amid falling revenue, job losses and a slow economy. Some states could reduce their borrowing, put it off until the economy improves or borrow directly from banks with which they already have a financial relationship, to avoid selling bonds on the open market and paying higher interest rates.
States that have retained the coveted AAA rating, which lowers their borrowing costs, are among those most nervous about the potential fallout.
New Mexico finance officials have had several meetings with Moody's over the past few weeks to justify the state's top rating. They have noted that the state has strong cash reserves and adequate property tax revenue, which supports general obligation bonds.
Virginia Finance Secretary Ric Brown said S&P and the two other major bond rating services recently affirmed his state's AAA rating. But the state remains on "negative outlook" because its economy is so intertwined with the federal government.
"The question is if the federal government goes down, then does it suck us down with it," Brown told The Associated Press over the weekend.
Another AAA-rated state, Tennessee, is sending a delegation to New York later this week to meet with officials at Moody's and Fitch. Finance Commissioner Mark Emkes said he wants to let the agencies know what steps the state has taken to remain in the black before they consider any changes to the state's rating.
"It would not have a major impact to our finances," he said of any potential future downgrade from AAA. "However, it's a prestigious thing, and we would like to hang on to it if at all possible."
S&P analyst Gabriel Petek said one strength of state and local governments is that while they receive federal aid, they are autonomous from the federal government. But he said the long-term concern is the pressure to reduce federal spending, which could intensify with the S&P downgrade.
Nicholas Johnson, vice president for state fiscal policy at the Center for Budget and Policy Priorities, said, the looming cuts ultimately could have an effect on states' bond ratings because the agencies are going to try to determine whether states governments can absorb the loss the federal money and take on the burden of providing those services.
One area of concern is health care programs.
California, for example, relies heavily on federal support for Medicaid, the state-federal health care program for the poor and disabled. The state's version is known as Medi-Cal and covers 7.5 million people in a state with a population of about 37 million.
California will spend about $15 billion of its own money on the program but is anticipating nearly $30 billion over the next year from the federal government.
"That," Petek said, "certainly seems like an area where there's vulnerability."
Last month, Moody's Investors Services threatened to downgrade the AAA rankings of South Carolina, Maryland, New Mexico, Tennessee and Virginia, noting they have a combined $24 billion in outstanding debt.
If the U.S. lost its AAA rating, Moody's said, those states are most vulnerable to being dragged down because of their reliance on federal money. In South Carolina, for example, one in five residents receives Medicaid benefits.
Moody's said it will be reviewing the states' credit over the next few months.
Maryland state Sen. David Brinkley, a Republican, said the federal rating downgrade was a message to national and state lawmakers that they have to get spending under control.
"It's not the end of the world," he said. "But I think it is a wake-up call that the current pattern is unsustainable."
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Associated Press writers Seanna Adcox in Columbia, S.C.; Jeri Clausing in Albuquerque, N.M.; Robert Lewis in Richmond, Va.; Judy Lin in Sacramento, Calif.; Erik Schelzig in Nashville, Tenn.; and Brian Witte in Annapolis, Md., contributed to this report.
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