This summer has brought discomfort from something besides the usual poison ivy, insects and sunburn—state budget dysfunction. Several states, including New Jersey, Maine, Washington, Alaska, Connecticut and Illinois, have struggled to pass budgets, with Illinois only averting a downgrade to a sub- investment-grade credit rating after a controversial tax hike. While the municipal bond market greeted the package of tax increases from nation’s 5th largest state with relief, states’ budget troubles may cause more anxiety in the future. Municipal-bond investors can, however, take comfort in knowing that defaults on state bonds are extremely unlikely. Moreover, careful security selection can help avoid exposure to volatility arising from fractious politics in state legislatures.
Many states face mounting obligations resulting from a combination of rising numbers of retirees and underfunded pension systems. In many cases, promises by governments to pay pensions in the future were not supported by the political will to begin funding those agreements from the outset.