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US Debt Default Would Make RI Budget Crisis Worse

Wednesday, July 13, 2011

 

If the President and Congress cannot reach an agreement on raising the U.S. debt ceiling, serious consequences would follow not only for the national economy, but also for the state budget in Rhode Island, a local economist and several government experts are warning.

“They’re playing with fire and I’m worried that a number of them don’t know what they’re messing with,” said Leonard Lardaro, an economist at the University of Rhode Island. “It’s probably more scary than people realize.”

If no agreement is reached, Lardaro said the federal government could enter into a technical default on its debt, potentially sending the economy spiraling into back into a recession and increasing the odds that Rhode Island itself—already struggling with a slow recovery—will sink into a double-dip recession.

Deadly domino effect

Rating agencies are poised to downgrade the U.S. bond rating, which Lardaro said could have a domino effect across the country. If U.S. debt is perceived as riskier, he said, state and municipal debt will be could be seen as even riskier. Additional downgrades in the bond rating for Rhode Island and the 39 cities and towns would increase the costs of borrowing money.

Other local experts agreed with Lardaro’s assessment. “If the markets go down that has consequences for individuals as well as public agencies,” said Gary Sasse, the former Director of the Department of Administration and former long-time head of the Rhode Island Public Expenditure Council.

“If the United States has to pay for its credit that could affect all states and municipal bonds,” he added.

Hit to state and local pension funds

Sasse warned that the impact would spread beyond state and local governments to their pension funds. “If there’s a general decline in the markets the pension funds are affected just as much as the personal investments,” Sasse said.

A lower return on investments can cost the state pension system billions, as the recent recession has shown. For example, between 2008 and 2009, the state pension system lost $1.5 billion—19.18 percent of its value—due to the decline in the economy.

Lost federal funds

Yet another major impact would be immediate. Rhode Island’s annual state budget depends on billions in federal funding—and much of that could be at risk if there is no deal on the debt ceiling. “All kinds of federal payments could be delayed,” Sasse said. “It really depends on what kinds of decisions the federal government makes about how it’s going to handle the trust funds.”

The current head of RIPEC, John Simmons, pointed to a national report that says nearly half of federal payments—44 percent to be exact—could be temporarily halted in August as federal officials struggle to stay within the debt limit.

The Bipartisan Policy Center report states that, “Under a system of prioritization, to pick one illustration, Treasury could exhaust all inflows for the month of August by paying only six major items: interest on our existing debt, Medicare, Medicaid, Social Security, unemployment insurance and defense contracts.”

That would leave no money for entire U.S. Departments, including Justice, Labor, and Commerce as well as no funding for veterans benefits, IRS refunds, military active duty pay, federal salaries and benefits, special education, and Pell grants, according to the report.

“The choices would not be pretty,” said Jay Powell, a former Under Secretary of the Treasury under President George H.W. Bush and visiting scholar at the center.

Governor Lincoln Chafee’s office declined to respond to questions about how the state is bracing for the potential fallout from failed negotiations over the debt ceiling.

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