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About 6 months ago, we warned you in The Weekly Commentary that Pennsylvania was heading for trouble with the current year’s budget and the budget shortfall might be so large as to result in a credit rating downgrade. Now, the Wall Street Journal has reported that this budget deficit forecast is becoming fact. The budget deficit widened significantly, from $720 million at the end of March to more than $1 billion on May 3, when the Pennsylvania Revenue Department disclosed that April income-tax collections were well below forecasts. Gov. Ed Rendell has proposed increasing taxes, cutting spending and shifting state funds to balance the budget. However, many reserves have already been consumed There is not much to fall back on. A credit downgrade is becoming more likely. Investors should avoid many Pennsylvania municipal bonds especially those with a maturity of more than 4 years.
Pennsylvania is only one example of the growing budget problem at the state level. Other examples are California (of course), Illinois, Florida, Nevada, Arkansas, Kansas, and Idaho – several additional states are suspected of having problems but have not yet released tax revenue data. The end result is that municipal bond investors can no longer sit back and simply collect their municipal bond interest. Municipal bond investors must now keep a very close eye on the fiscal distress signals of each of their issuers or sell their municipal bond holdings and wait on the sidelines until the uncertainty is reduced.