Debt, defense and downgrades

By Norman Leahy | Monday, November 28th, 2011 | Economics, Policy, Politics, Virginia

Lurking in the background of the supercommittee’s failure to find budget savings is how, if at all, the credit ratings agencies would react.

So far, Fitch, Moody’s and Standard & Poor’s are biding their time. Moody’s and Fitch may move to a negative outlook on U.S. debt, while S&P, which famously took the nation’s debt down a notch over the summer, isn’t contemplating a further downgrade.

All of this has particular meaning for Virginia, which, like other AAA-rated states, was warned that its debt rating would suffer if the federal government either lost its own AAA rating or defaulted.

This possibility, which would raise Virginia’s debt service payments and thus squeeze-out other budget items, appears to be off the table. For now.

But don’t get cocky. The supercommittee’s punt will result in a sequester (in 2013). While the proposed cuts will be spread out over a decade, and barely dent the overall rise in federal spending during the same period, half of the proposed savings come from defense spending. And that’s Virginia’s Achilles heel.

Or so the thinking goes. Finance Secretary Ric Brown is worried about those looming cuts, but believes the real pain won’t come for several years:

Defense cuts would not necessarily hurt Virginia, at least not in the short term, he said. If cuts lead to consolidation of military installations, the state could wind up gaining jobs, as it did under the Base Realignment and Closure process, Brown said. And some military contracts, such as ship-building for the Navy, are unlikely to be broken, he said.

“You have to get out to 2018 before you start to feel the pinch on that [ship-building],” he said.

But steep cuts are likely to hurt the state eventually, and perhaps dramatically, he said.

“Sooner or later, it catches up with us,” he said. “It’s not so much immediately. It’s the longer term. … There are going to be cutbacks and that will affect Virginia in the longer haul because the federal government is a big part of our economy.”

Read another way: the next administration will have to handle the fallout — assuming the federal spending cuts actually occur.

But the larger point is that Virginia has enjoyed a boom in defense spending over the last decade. Those days appear to be over. Before the party comes to a screeching halt, though, Virginia has an opportunity to accelerate its diversification away from federal spending and toward the private sector (such as in energy exploration and development…if such activities are allowed).

Failure to make this move will result in larger and more protracted budgetary woes in the future — and put fresh, new pressures on the state’s AAA rating.

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