Of the movie business, the screenwriter William Goldman once famously observed: "Nobody knows anything." I wonder if the same isn't true for financial markets.
We've barely begun to see the impact on transportation infrastructure funding of Standard & Poor's downgrade of the United States' long-term sovereign credit rating. The full implications might not be felt for years. Much depends on the actions of Congress and the White House over the next two years. But it's safe to say that the outlook for transportation isn't very rosy.
S&P's action was an expression of the credit-rating agency's frustration over the inability of lawmakers to agree on a rational plan for reducing the federal deficit. The whole thing was triggered by fierce debate over raising the nation's debt ceiling, an action that previously had been carried out without drama by Republican and Democratic administrations alike. What made S&P especially nervous was the Tea Party-fueled opposition to any kind of tax increase. The battle raised the possibility that the U.S. would be unable to meet its financial obligations, on everything from payouts on government bonds to salaries for federal workers.
"S&P did the downgrading because the political process was so chaotic that they lost hope that Washington would actually avoid a default," says James Gellert, chief executive officer of Rapid Ratings International Inc. Fortunately, Congress and President Obama reached a last-minute agreement on raising the debt ceiling. But the deal might carry a heavy price for transportation.
The immediate concern is extending the current law for funding highway projects, SAFETEA-LU, which expires Sept. 30. S&P isn't optimistic about the outcome. "Given that, in our opinion, the effectiveness, stability, and predictability of American policymaking and political institutions have weakened, as demonstrated during the recent debt ceiling debate, there is the possibility that the surface transportation funding debate will be similar," the agency says in a recent report on the outlook for transportation project financing.
S&P doesn't expect its downgrade to have a direct impact on Grant Anticipation Revenue Vehicle (Garvee) bonds, which are issued by states to fund highway improvements and other transportation projects. The instruments depend on future federal aid for repayment, although they aren't guaranteed.
S&P optimistically assumes that "the government will take timely action to support these programs and their related bonds." As a result, its ratings on Garvee bonds retain a stable outlook. At the same time, the agency is concerned about several factors that could alter the bonds' solid credit rating.
One is the prospect of sharply reduced federal spending on transportation programs, as a result of the August budget deal. Lawmakers have to come up with at least $2.4tr in budget cuts over the next 10 years, and transportation won't be immune. Says S&P: "Any lowering of authorizations and appropriations levels could affect our opinion about what we generally view to be very strong coverage for most of our rated Garvee bonds."
The budget "compromise" comes at a time when the nation's infrastructure is in dire need of fresh funding for maintenance and new construction. So a lot depends on the ability of Congress and the Administration to agree on a lasting replacement for SAFETEA-LU, including an increase in the federal gas tax - then use that money to fund transportation projects, instead of paying down the deficit. The gas tax is a major source of funding - in some cases the only source - for repaying Garvee bonds. "Any delay or reduction in this funding source could have credit ramifications," the agency says.
One could find hope in last week's vote by the House of Representatives to extend funding authorization under SAFETEA-LU through March 31, 2012. House members were predicting that the Senate would follow suit, given that the measure only maintains current spending levels. But a six-month extension - the eighth since SAFETEA-LU officially expired on Sept. 30, 2009 - does nothing to set the stage for a long-term program.
While S&P's downgrade isn't a direct reflection on the credit rating of corporate borrowers, it could have a serious ripple effect on the private sector. Uncertainties stemming from the acrimonious political debate have already roiled financial markets in the U.S. and abroad.
"In the sense that market disruption creates overall capital market volatility, it makes it that much more difficult for companies to act on capital," says Gellert. "It's hard to know what your cost of capital will be when markets are bouncing around. Even though individual corporations are tapping slightly different portions of the investor community, they are still subject to underlying interest rates, and perceptions of overall credit risk."
Gellert sees a direct link between the S&P downgrade and public spending at the local level. Municipal borrowers have historically enjoyed low default rates and relatively easy access to capital, but that state of affairs isn't likely to continue. "Almost immediately," says Gellert, "S&P put a wide number [of municipalities] on watch for downgrade."
Some municipal borrowers have struck back by dropping S&P as a ratings service. Indeed, the agency can hardly be considered the last word on creditworthiness. It was responsible for doling out Triple A ratings to some extremely dicey mortgage-based bonds, one of the reasons behind the housing bubble and subsequent crash. And the other two major rating agencies, Moody's Investors Service and Fitch Ratings, didn't follow S&P in downgrading U.S. credit. But both are watching developments closely. For better or worse, these three entities hold sway over the investor community. So Congress and the President will have to tread carefully, if we are to avoid further economic calamity - and the treatment of the nation's transportation infrastructure as collateral damage.
Next: How can supply chains protect themselves against economic uncertainty?
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