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STATE AND MUNICIPAL DEBT: THE COMING

CRISIS? PART II

HEARING

BEFORE THE

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES

AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

OF THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

MARCH 15, 2011

Serial No. 112–42

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.fdsys.gov

http://www.house.gov/reform

(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

DARRELL E. ISSA, California, Chairman

DAN BURTON, Indiana

JOHN L. MICA, Florida

TODD RUSSELL PLATTS, Pennsylvania

MICHAEL R. TURNER, Ohio

PATRICK T. MCHENRY, North Carolina

JIM JORDAN, Ohio

JASON CHAFFETZ, Utah

CONNIE MACK, Florida

TIM WALBERG, Michigan

JAMES LANKFORD, Oklahoma

JUSTIN AMASH, Michigan

ANN MARIE BUERKLE, New York

PAUL A. GOSAR, Arizona

RAU ́ L R. LABRADOR, Idaho

PATRICK MEEHAN, Pennsylvania

SCOTT DESJARLAIS, Tennessee

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

FRANK C. GUINTA, New Hampshire

BLAKE FARENTHOLD, Texas

MIKE KELLY, Pennsylvania

ELIJAH E. CUMMINGS, Maryland, Ranking

Minority Member

EDOLPHUS TOWNS, New York

CAROLYN B. MALONEY, New York

ELEANOR HOLMES NORTON, District of

Columbia

DENNIS J. KUCINICH, Ohio

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

STEPHEN F. LYNCH, Massachusetts

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

MIKE QUIGLEY, Illinois

DANNY K. DAVIS, Illinois

BRUCE L. BRALEY, Iowa

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

CHRISTOPHER S. MURPHY, Connecticut

JACKIE SPEIER, California

LAWRENCE J. BRADY, Staff Director

JOHN D. CUADERES, Deputy Staff Director

ROBERT BORDEN, General Counsel

LINDA A. GOOD, Chief Clerk

DAVID RAPALLO, Minority Staff Director

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND BAILOUTS OF PUBLIC AND

PRIVATE PROGRAMS

PATRICK T. MCHENRY, North Carolina, Chairman

FRANK C. GUINTA, New Hampshire, Vice

Chairman

ANN MARIE BUERKLE, New York

JUSTIN AMASH, Michigan

PATRICK MEEHAN, Pennsylvania

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

MIKE QUIGLEY, Illinois, Ranking Minority

Member

CAROLYN B. MALONEY, New York

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

JACKIE SPEIER, California

JIM COOPER, Tennessee

(III)

C O N T E N T S

Page

Hearing held on March 15, 2011 ............................................................................ 1

Statement of:

Liljenquist, Hon. Daniel, Utah State Senator; Robin Prunty, managing

director, Ratings Services, Standard and Poor’s Financial Services LLC;

Dean Baker, co-director, Center for Economic and Policy Research;

Robert Kurtter, managing director, Moody’s Investors Service; and Andrew G. Biggs, resident scholar, American Enterprise Institute for Public Policy Research ........................................................................................ 11

Baker, Dean ............................................................................................... 27

Biggs, Andrew G. ....................................................................................... 46

Kurtter, Robert .......................................................................................... 36

Liljenquist, Hon. Daniel ............................................................................ 11

Prunty, Robin ............................................................................................ 16

Letters, statements, etc., submitted for the record by:

Baker, Dean, co-director, Center for Economic and Policy Research, prepared statement of ........................................................................................ 29

Biggs, Andrew G., resident scholar, American Enterprise Institute for

Public Policy Research, prepared statement of .......................................... 48

Kurtter, Robert, managing director, Moody’s Investors Service, prepared

statement of ................................................................................................... 38

Liljenquist, Hon. Daniel, Utah State Senator, prepared statement of ........ 14

McHenry, Hon. Patrick T., a Representative in Congress from the State

of North Carolina, prepared statement of ................................................... 4

Prunty, Robin, managing director, Ratings Services, Standard and Poor’s

Financial Services LLC, prepared statement of ......................................... 18

Quigley, Hon. Mike, a Representative in Congress from the State of

Illinois, prepared statement of the National Education Association ........ 8

(1)

STATE AND MUNICIPAL DEBT: THE COMING

CRISIS? PART II

TUESDAY, MARCH 15, 2011

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND

BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS, COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM, Washington, DC.

The subcommittee met, pursuant to notice, at 1:42 p.m. in room

2154, Rayburn House Office Building, Hon. Patrick T. McHenry

(chairman of the subcommittee) presiding.

Present: Representatives McHenry, Amash, Buerkle, Meehan,

Walsh, Guinta, Quigley, Maloney, Welch, and Speier.

Also present: Representatives Issa, and Cummings.

Staff present: Robert Borden, general counsel; Sharon Casey,

senior assistant clerk; Steve Castor, chief counsel, investigations;

Benjamin Stroud Cole, policy advisor and investigative analyst;

John Cuaderes, deputy staff director; Gwen D’Luzansky, assistant

clerk; Adam P. Fromm, director of Member liaison and floor operations; Tyler Grimm and Ryan M. Hambleton, professional staff

members; Peter G. Haller, senior counsel; Christopher Hixon, majority deputy chief counsel, oversight; Justin LoFranco, press assistant; Mark D. Marin, senior professional staff member; Becca

Watkins, deputy press secretary; Jason Powell and Steven Rangel,

minority senior counsels; Cecelia Thomas, minority counsel/deputy

clerk; and Davida Walsh, minority counsel.

Mr. MCHENRY. The committee will come to order.

This is a meeting of the TARP, Financial Services and Bailouts

of Public and Private Programs subcommittee. The hearing is entitled State and Municipal Debt: The Coming Crisis?

At the beginning of this hearing, as I do with all subcommittee

hearings, I read the mission statement of the Oversight and Government Reform Committee. So that is what I will do now.

The Oversight Committee mission statement: We exist to secure

two fundamental principles. First, Americans have a right to know

that the money Washington takes from them is well spent. And

second, Americans deserve an efficient, effective government that

works for them.

Our duty on the Oversight and Government Reform Committee

is to protect these rights. Our solemn responsibility is to hold government accountable to taxpayers because taxpayers have a right

to know what they get from their government.

We will work tirelessly in partnership with citizen watchdogs to

deliver the facts to the American people and bring genuine reform

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to the Federal bureaucracy. This is the mission statement of the

Oversight and Government Reform Committee.

With that, I will recognize myself for 5 minutes for an opening

statement.

This hearing is the second installment of the subcommittee’s efforts to examine the causes and severity of fiscal problems facing

States and municipalities. Today will explore the magnitude of the

growing budget liability of State and municipalities, and its origins.

From years of unwise fiscal policy to reckless management and collusion between elected officials and the public sector unions, a crisis has emerged as a great expense to the American people.

It also has an impact on our markets. It also has an impact on

people’s savings, especially for retirement.

Leading economists have already labeled 2012 as the States’

most difficult budget year on record. Forty-four States and the District of Columbia are now projecting aggregate budget shortfalls totaling $125 billion this year alone. It only gets worse each year. Even more threatening is the $3.2 trillion in unfunded State pen- sion liabilities, and another $383 billion liability for local governments.

To be sure, the budget crunch is closely associated with the larger economic stresses facing the country. But years of unchecked

spending and overly generous benefits have taken their toll. There

are $3 trillion in municipal bonds outstanding across the country.

Many State and municipal governments face the real possibility of

defaulting on their debt.

Ultimately, this hearing is about two things. First, what is the

real debt burden facing States and municipalities? Second, what

must be done to mitigate the immediate crisis and put these governments back on solvent fiscal paths?

But let me restate for the record what I said in Part I of this

hearing, back on February 9th: the era of the bailout is over. Let

me repeat: taxpayer bailouts are not on the table. The past 21⁄2

years of wasteful spending and irresponsible policy under the guise

of economic stimulus and emergency economic stabilization have

emptied the Treasury of every thin penny. And even if Washington

had more money to spread around, a bailout would only serve to

delay the coming day of judgment, pushing on our children and

grandchildren the burden of paying for our irresponsible spending.

There must be other options, and this series of hearings is about

assessing those options, first understanding the problem, and assessing our options to move forward.

Some States are making bold efforts at reform. In 2009, for instance, the State of Utah experienced such massive losses due to

the market collapse that taxpayer contributions to workers pensions would have to rise to $420 million annually to keep them

afloat. Senator Dan Liljenquist, however, successfully championed

a plan for reform that will allow the State to remain solvent and

enjoy greater budget flexibility. Senator Liljenquist, thank you for

being here today. I look forward to your comments.

At the executive level, Governors like Chris Christie of New Jersey and John Kasich of Ohio have begun to push piece by piece legislation to reform their pension plans gradually. While still others,

like the State of Wisconsin, for instance, have become the proving

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grounds for the future. Last week, Governor Scott Walker made

good on his promise to voters to overhaul the entire structure of

public sector unions in the State. That is a bit of controversy, of

course, even the President has commented upon that. Governor

Walker’s legislation has met with great resistance, but fomenting

political chaos will not help to serve or fix this fiscal crisis.

The question before us today may require careful, sober consideration. And it is critical and critically important that Congress examine the State and municipal fiscal crisis and judiciously evaluate

reasonable policy options. Today’s witnesses are all experts in that

field, and the subcommittee will give them an attentive ear.

With that, I yield 5 minutes to the ranking member, Mr. Quigley

of Illinois.

[The prepared statement of Hon. Patrick T. McHenry follows:]

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Mr. QUIGLEY. Thank you, Mr. Chairman.

Before I begin, I ask unanimous consent to have a statement

from the National Education Association be entered into the record.

Mr. MCHENRY. Without objection.

[The information referred to follows:]

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Mr. QUIGLEY. Thank you.

Mr. Chairman, I would like to thank you for convening today’s

hearing, the second hearing on State and municipal debt. I would

also like to thank our five witnesses for contributing their time and

expertise.

In fiscal year 2012, 44 States are projected to have a budget deficit of at least 5 percent. Although troubling, this is a short-term

fiscal problem that has more to do with the current economic downturn than with underfunded pension programs. Once the economy

gets going, State revenues will go up and budget deficits will

shrink.

In the long term, however, we have an accounting problem

unique to six or eight States, among them Illinois, California, Ohio,

and New Jersey. For years, under both Republican and Democratic

leadership, these States have grossly underfunded their pension

programs.

No one has to tell me there is a problem. I am from Illinois. Illi- nois is one of the worst examples, with $162 billion unfunded liability. Its pension system is less than 50 percent underfunded. This

level of under funding is reflected in Illinois’ bond rating. In the

last 5 years, its bond rating has taken a nose dive. Before it raised

taxes, an outcome nobody wanted, its bonds were considered only

slight less risky than Iraq’s.

Its bond rating is still poor. And that means it is much more expensive for Illinois to borrow money. According to Laurence Msall

of the Civic Federation, bad bond ratings were costing Illinois taxpayers $551 million extra per year in interest payments. States

like these need to take common sense steps to shore up their pension systems.

Reform is important not only to protect taxpayers, but also to

protect the beneficiaries of public sector pensions. These pension

systems provide retirement security for millions of Government

workers. We have a responsibility to ensure that we are not shortchanging them.

Pension reform should restore long-term solvency to pension systems, so that workers can depend on a steady retirement income.

We can keep defined benefit plans, while taking reasonable steps

like increasing worker contributions and realigning retirement age,

COLAs, and term of service. In some States like Illinois, pension

reform will have to go farther than in others.

What we have to avoid is a one size fits all approach that doesn’t

distinguish between the bad apples and the good. And we also have

to remember that the onus must be on State governments to reform themselves. One model for troubled States might be the recent series of pension reforms in Massachusetts. Under Governor

Deval Patrick, Massachusetts has passed several pension reform

packages. Just earlier this year, in January, the Governor proposed

eight reforms that would improve the long-term sustainability of

the State’s pension system. Officials have estimated that these reforms will save Massachusetts billions of dollars over the next 30

years. They are also an important step toward a higher bond rating

and lower borrowing costs.

On February 8th, the Bond Buyer reported that Standard and

Poor’s revised Massachusetts’ outlook to positive from stable, based

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on strong management practices. Of course, every State and municipality is different, and pension reform would have to be tailored

to each specific situation. Still, the Massachusetts example demonstrates that pension reform can be achieved that not only increases bond ratings but decreases borrowing costs, and that also

protects workers and guarantees them a steady retirement income.

I thank the chairman and I yield back.

Mr. MCHENRY. I thank the ranking member, and I certainly appreciate the panel being here today.

Members will have 7 days to submit opening statements for the

record. We will recognize the panel now. I will introduce the whole

panel, then we will begin with you, Senator Liljenquist, to give

your opening statement.

The Honorable Dan Liljenquist is a member of the Utah State

Senate. Mr. Robert Kurtter—I sorry, I am bouncing around—is the

managing director for U.S. State and Regional Ratings at Moody’s.

Mr. Dean Baker is co-director of the Center for Economic and Policy Research. Thank you, Mr. Baker, Dr. Baker, I am sorry. Ms.

Robin Prunty is the Team Leader for State Ratings at Standard

and Poor’s. And Mr. Andrew Biggs is a resident scholar at the

American Enterprise Institute for Public Policy Research.

It is the policy of the committee that all witnesses be sworn in

before they testify. So if you will please rise and raise your right

hands.

[Witnesses sworn.]

Mr. MCHENRY. You may be seated. Let the record reflect that all

the witnesses answered in the affirmative.

Now, in order for us to have time for discussion, we do have

votes on the floor in less than an hour, so if you could keep your

comments to 5 minutes. The clock will register for you, as you can

see, with 1 minute remaining it moves from green to yellow. That

means hurry on up and finish. And any time that you don’t use is

really a gift. So if you can summarize your statements, we will also

let you offer your full statements for the record.

With that, Senator Liljenquist, you are recognized for 5 minutes.

STATEMENTS OF HON. DANIEL LILJENQUIST, UTAH STATE

SENATOR; ROBIN PRUNTY, MANAGING DIRECTOR, RATINGS

SERVICES, STANDARD AND POOR’S FINANCIAL SERVICES

LLC; DEAN BAKER, CO-DIRECTOR, CENTER FOR ECONOMIC

AND POLICY RESEARCH; ROBERT KURTTER, MANAGING DIRECTOR, MOODY’S INVESTORS SERVICE; AND ANDREW G.

BIGGS, RESIDENT SCHOLAR, AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

STATEMENT OF HON. DANIEL LILJENQUIST

Mr. LILJENQUIST. Thank you, Chairman McHenry, Ranking

Member Quigley and members of the committee. It is an honor to

be with you today.

If there is an upside of an economic downturn, it is that taxpayers throughout the United States are waking up to the massive

liabilities incurred by State and local governments. In particular,

financial commitments made to public employees are driving policy

debates throughout this country. Defined benefit pensions are at

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the heart of these policy debates, as policymakers wrestle with the

approximately $3 trillion unfunded pension liabilities.

For years, public employee pension plans have largely been exempted from taxpayer scrutiny because of the long-term nature of

pension commitments and the assumption that today’s market

losses will be made up by tomorrow’s gains. However, the market

crash of 2008 revealed just how much market risk taxpayers are

bearing to guarantee pension benefits for public employees.

Utah’s pension system is a case in point. If I might, I would like

to spend a couple of minutes discussing the situation in Utah.

Going into 2008, Utah’s public employees pension systems were

over 100 percent funded. Utah has always paid the full required actuarial contribution to its pension systems, and has not raised retirement benefits for 20 years. Utah’s retirement system has been

and still is recognized as one of the best-run pension systems in the

country.

However, market losses in 2008 blew a 30 percent hole in Utah’s

pension fund, opening up a $61⁄2 billion unfunded liability. To put

this number in perspective for the State of Utah, our constitutional

debt limit is set at 11⁄2 percent the total assessed value of real

property in the State. That value is currently $4.4 billion, and we

borrowed $3.3 billion of that $4.4 billion or approximately 75 percent.

Adding Utah’s official debt to Utah’s newly recognized unfunded

pension liabilities, Utah’s total debt is $9.8 billion, which is 223

percent of Utah’s constitutional debt limit.

In the fall of 2009, Utah’s Joint Retirement Independent Entity

sub-appropriations committee, of which I am the Senate co-chair,

requested an in-depth actuarial review of Utah’s pension liabilities.

For the first time in our State, we asked our actuaries, instead of

looking in the rearview mirror, to look forward for 40 years and assess a variety of scenarios to give us a better understanding of

where we are going. The report highlighted some troubling facts.

First, we realized that Utah, and I would say any other State,

if you look forward, cannot grow its way out of these pension problems. We would have to average, in Utah, 13 percent returns year

over year for 20 years to grow out of the 2008 losses. If Utah’s pension system averages its assumed 7 3/4 rate of return, and we do

nothing else, Utah’s pension system will be bankrupt by approximately 2040.

Second, we realize Utah must dramatically increase contributions to the pension system required to compensate for the 2008

losses. These contributions will increase and continue to increase

over the coming years, and stay there for an amortization period,

which is 25 years. Our total contributions will equate to approximately 10 percent of Utah’s general and education funds for 25

years to pay off 1 year’s worth of losses.

Finally, the study from our actuaries showed that Utah cannot

absorb another year like 2008. For example, if we hit a 6 percent

return over the next 25 years, we are bankrupt now as a State and

don’t know it. Because we are hoping that we can get the market

returns we need to meet the commitments we have made to our

employees.

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Last year, the Utah legislature acted aggressively to cap its existing pension liabilities. We closed our defined benefit pension

plans to new enrollees, creating a new retirement system for new

public employees hired after July 1, 2011. The crux of our pension

reforms are that the State will no longer have an open-ended guarantee to its public employees. Instead, we are saying affirmatively

we will put a certain amount toward retirement, and that is what

you get.

Employees have the option to choose between a 401(k) style plan

and also a defined benefit pension hybrid plan. But they are on the

hook for the market risk.

It is our hope in the State of Utah, as we have tried to manage

all our liabilities and risks, that other States will follow suit. It is

now time to act and make sure we are containing these liabilities,

so we can move forward as a State and as a country. Thank you.

[The prepared statement of Mr. Liljenquist follows:]

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Mr. MCHENRY. Ms. Prunty.

STATEMENT OF ROBIN PRUNTY

Ms. PRUNTY. Thank you, Mr. Chairman, Mr. Ranking Member,

members of the committee. Good afternoon. My name is Robin

Prunty, and I am a managing director in Standard and Poor’s Ratings Services business. I am an analytic manager in charge of the

State ratings group.

Standard and Poor’s is a credit rating agency and as such conducts analysis and forms forward-looking opinions about the creditworthiness of debt and debt issuers, including among others, States

and municipalities. I am pleased to appear before you today.

Standard and Poor’s believes that the difficulties faced by States

and municipalities will give rise to very difficult budget and policy

decisions, but not default for our rated universe in the overwhelming majority of cases. This is because State and municipal

debt obligations are secured either by a specific pledge of the Government’s full taxing authority or dedicated taxes, user revenues or

fees. And there is often a priority status for debt relative to other

obligations.

Because States and in many cases local governments are required to balance their budgets rather than finance budget deficits

solely through debt issuance, they are annually making choices to

align revenues and expenditures. These actions, along with the

Federal stimulus funding, contributed to relative credit stability for

most U.S. public finance issuers. While credit downgrades have increased over the last 2 years, and we expect there could be further

credit deterioration in 2011, in the majority of cases, we believe

that general obligation and other types of direct debts of State and

local governments that we rate will continue to be retired as scheduled.

Over the past 25 years, there have been 42 defaults for non-housing issues in U.S. public finance at Standard and Poor’s. There has

been observed default by a State in more than 100 years. Although

the number of defaults has been, relatively speaking, low, we do

believe the securities issued by rated governments can still face

meaningful default risks.

Because of the slow progress of the recovery from the recession,

S&P believes that the continued flat or slow revenue growth transfers State and local governments may add to strain on budgets and

overall liquidity, especially in the short term, as Federal stimulus

funds end. In addition, we believe that pensions and other post-employment benefit obligations represent material long-term risks to

governments, and have long been factored into our criteria for rating State and local governments. Recent investment performance of

the assets in most pension trust fund is well below historic trends

and negative in many cases, which has contributed to weakened

pension funding levels. Governments that are not funding their annual required contributions risk the most significant changes in

their budget capacity in the future.

Such concerns have given rise to pension reform movements in

certain States, and we expect that this will continue. While we believe that liabilities to public employees represent genuine longterm pressures on government credit quality, they generally are

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not immediately competing for most governments’ capacity to fund

their debt service or meet other priority payment obligations.

In general, we believe that the worst-case scenarios regarding

pensions will likely occur only if governments are unable or unwilling to use their powers of adjustment. Notwithstanding the difficult

policy choices facing State and local governments, S&P continues

to expect that most issuers that we rate will continue to retain

their strong capacity and willingness to meet their debt obligations.

Moreover, there is little incentive for them to allow their debt obligations to default. This is in part because we believe that a defaulted debt service payment would likely result in a loss of access

to the capital markets, which has been a significant source of funding for capital and infrastructure projects for both State and local

governments.

We have observed that governments have made many improvements to their budget structure, reserve policies and debt management during prior periods of budget stress, which in our view has

generally enhanced their ability to manage through downturns.

Reconciliation of structural revenue and expenditure misalignments may not be achieved in one fiscal year, but reform efforts are

underway for many governments. We expect that this will continue

through 2011.

Effective financial management will be key to addressing these

challenges. And governments have strong powers of adjustment. If

governments do not manage or make adjustments, and instead rely

heavily on debt and other one-time solutions in the hope that economic growth will balance their budgets, we believe that they could

be setting themselves up for greater hardship in the near term.

Throughout difficult economic periods, including during and after

this most recent recession, we have generally seen on the part of

governments what we consider to be a very strong commitment to

their debt obligations, which for us has been an important credit

consideration over time. While there are vulnerabilities in the public finance sector, our expectation is that the threat of default is

generally not widespread among State and municipal issuers that

we rate.

I thank you very much for the opportunity to participate in this

hearing, and would be happy to answer questions that you may

have.

[The prepared statement of Ms. Prunty follows:]

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Mr. MCHENRY. Thank you, Ms. Prunty. That was probably the

most amazing use of time. Well done, thank you.

Dr. Baker.

STATEMENT OF DEAN BAKER

Mr. BAKER. Thank you, Chairman McHenry and Ranking Member Quigley. I want to thank in particular Representative Quigley.

I am also from Illinois, and my mother is one of those public employees who is dependent on the pensions there. So I appreciate

your concern.

I want to make three main points in my comments today. First

off, that the financial strain facing State and local governments

first and foremost originates in Washington, or perhaps I should

say Wall Street. It is a problem of the economy, and that is where

most of the difficulties stem from. Second, the problems that our

pension funds face are manageable. And the third point is that the

pension fund accounting is, for the most part, reasonable, that they

are looking at expected returns on their pension funds. Requiring

pension funds to use a risk-free rate of return in assessing their

funds could lead to higher costs and possibly ending defined benefit

plans altogether, which I would argue would mean higher costs for

taxpayers.

First point, the fact that the problems originate in Washington

should be fairly straightforward. We are 3 years, 2 months into a

recession. The unemployment rate is still 41⁄2 percentage points

higher than it was prior to the downturn. If we compare that to

the last serious recession, 1981, 1982, we already were back a the

pre-recession level of unemployment. It is reasonable to expect

State and local governments to prepare for downturns, but this is

an extraordinary one, without precedence. This was due to mismanagement here in Washington, at the Federal Reserve Board, irresponsibility on Wall Street. This is not your run of the mill recession.

And just an idea of how much difference that makes, we are currently 6 percent below potential GDP. If we assume that State revenues were 6 percent higher, a good first approximation, most of

these States would have no problems at all balancing their budget.

In the case of Wisconsin, which of course has been in the news lately, they would have $4 billion in additional revenue over the 2-year

horizon, fully making up their shortfall, before even taking into account the savings on expenditures for programs like unemployment

insurance, TANF and other expenditures that have increased during the downturn.

So this is first and foremost a problem that originates in Washington. Not to say that all governments are responsible, but certainly the problems were enormously worsened by the severity of

the downturn.

The second point, oftentimes we scare people by using big numbers. The pension liabilities, however, estimated, are very big numbers. But if we calculate them relative to the size of the future

economy, over a 30-year period, the normal horizon, we are looking

at a shortfall that by my calculations is a little more than twotenths of a percent of GDP. That is hardly trivial, but if we compare that, say, to the increase in defense spending from 2000 to

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2011, that was 1.7 percentage points of GDP. So the amount of additional revenue, whether through tax increases or reduction in

other spending, is about one-eighth as much as we found to increase our defense spending, defense budget, between 2000 and the

present. Not to say that is trivial, but that it is very much a manageable sum.

The last point I will make is that I would say that the pension

funds are using appropriate accounting. They are using expected

values. And I will say that I have been a critic of their accounting

in years past, in the 1990’s and the 2000’s when you had very high

price to earnings ratios. They were making assumptions about future stock returns that were clearly unrealistic. I said that quite

openly at the time.

Now that you have had a big fall in the stock market, going forward, the given price to earnings ratios and given growth projections from the Congressional Budget Office and other major forecasters, their assumptions on rates of return are very realistic.

The alternative, if we are to insist the pension funds use a riskfree rate of return, we would have two stories we could tell. One

is that they continue to invest in equities, but they assume a riskfree rate of return. This would, in effect, require pre-funding. This

would be very perverse policy, it would mean more taxes or less

spending in the current to have savings in the future. We might

think that prudent in some sense, but I don’t know of anyone who

has recommended pre-funding schools, pre-funding fire departments. That is not ordinarily the way we expect our governments

to function.

The alternative is to say, OK, they would just invest in bonds

and get the lower risk-free rate of return. If we did that, pension

fund would be more costly to State and local governments, which

would mean a higher burden to taxpayers.

The final possibility is we could end up eliminating them altogether, which as we know some States have done, some local governments have done. This again is a cost to taxpayers, if we think

this through carefully. Defined benefit pensions are something that

workers value greatly.

The fact is that State and local governments can endure timing

risks with the stock market, because they are essentially infinitely

live entities. Individuals, of course, have finite lives. For individuals, it is a very, very big risk. By virtue of taking that risk, we

are able to get either better employees for the same wages, or the

same employees for lower wages. That is a benefit that workers get

in exchange for other compensation.

If State and local governments no longer take advantage of their

indifference to risk, they end up losing that benefit. That will cost

taxpayers more money. Thank you.

[The prepared statement of Mr. Baker follows:]

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Mr. MCHENRY. Thank you, Dr. Baker.

Mr. Kurtter.

STATEMENT OF ROBERT KURTTER

Mr. KURTTER. Thank you. Good afternoon, Mr. Chairman, Congressman Quigley and members of the subcommittee.

My name is Robert Kurtter. I am a managing director in the U.S.

public finance group at Moody’s Investors Service. I want to thank

you for inviting Moody’s to share our views as pat of today’s hearings.

My comments will focus on the credit risk of public finance bonds

that are rated by Moody’s. A significant number of public finance

bonds are not rated by Moody’s or any other rating agencies. Because unrated issuers and bonds may have quite different risk

characteristics than rated ones, my comments should not be generalized to the entire universe of public finance bonds.

I also want to be clear that Moody’s opinions in this sector speak

only to the likelihood that a Government-issued bond is likely to

be paid in full and on a timely basis. While we take into account

all of an issuer’s major financial obligations, we do so in order to

assess the likelihood that an issuer can and is willing to meet its

payment obligations to bond investors. This means that when we

use the term default, we are referring specifically to the failure to

make payments to bondholders, and not a failure to fulfill any

other obligations a State or local government may have, such as

utility payments, salaries due to employees or pension liabilities.

I will turn now to our views on the sector. All of us here today

know that State and local governments are experiencing unprecedented financial strain. This is reflected in the negative outlooks

Moody’s has had on all major subsectors in this market. For State

and local governments, our negative views are driven by four main

factors.

First, the overall economy is still fragile, even though it is recovering. Second, State and local governments are facing increased liabilities, such as pension and health care costs. Many commentators have recently focused on pension liabilities. Moody’s has long

factored these liabilities into our analysis and opinions. Growing

unfunded pension obligations are creating challenges for these

issuers. And we are monitoring the situation closely. We have

taken and will continue to take rating actions where we believe an

issuer’s credit profile warrants it.

Third, lingering fiscal pressures have required State and local

governments to make severe budget cuts, use budget reserves and

pursue other non-recurring solutions to solve their budget gaps.

And finally, revenue sources have strained due to persistent high

unemployment, sagging real estate prices, which lead to drags on

taxes.

Let me focus now specifically on the condition of the U.S. States.

Most States are facing challenges with respect to both their liabilities and their revenues. The recovery is still fragile, unemployment is very high, and it is uncertain when sustained revenue

growth will take hold. That said, Moody’s does not see bondholder

debt as a source of credit strain for most States. This is because

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annual bond debt service costs remain a relatively small share of

overall expenditures.

In addition, most States do not face refinancing or material rollover risks. We believe that we could see a few more States turn to

deficit financings to fund operating expenses, or restructurings to

produce budget savings in 2011. But we expect those States to be

the exception rather than the rule. For these reasons, and because

of the strong incentives they have to pay their bond debt, we believe it is very unlikely that any States will default on their bond

obligations in the next 12 to 18 months.

In the local Government sector rated by Moody’s, we see unprecedented financial strain for the reasons I mentioned earlier. Further, the States can shift some costs to the local government level,

which is likely to exacerbate the challenges there. However, we

also expect that a majority of the individual local governments will

make the tough decisions and the budget cuts needed to continue

to make timely payments on their bonds.

We do not expect widespread defaults by rated State and local

governments. However, there have been situations in the past

where the risk of default seemed imminent, even though it was ultimately averted. We saw this, for example, in Harrisburg, Pennsylvania. We expect there will be some additional cases of severe

credit stress going forward.

In summary, there is substantial credit pressure on the U.S. public finance sector today. Over the next 12 to 18 months, we believe

it is unlikely that any State will default on its obligations to bond

investors. We believe the increase in bond defaults among local

governments will be relatively small.

Thank you again for inviting me to testify on this important matter. I look forward to answering your questions.

[The prepared statement of Mr. Kurtter follows:]

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Mr. MCHENRY. Thank you, Mr. Kurtter.

Dr. Biggs.

STATEMENT OF ANDREW G. BIGGS

Mr. BIGGS. Chairman McHenry, Ranking Member Quigley and

members of the committee, thank you for offering me the opportunity to testify with regard to State and municipal finances and

the role that public pension financing may play.

It is my hope that State and local finances will avoid a severe

disruption. Like a plane buffeted by turbulence, they will survive

so long as they had sufficient altitude before the event. My greatest

concern is not so much for this recession as the next one, which inevitably will come. If we enter that one in precarious financial position, State and local governments may not have sufficient room to

maneuver.

The rising costs of public sector pensions, while not the main

driver of State and local financial problems, have gained increasing

prominence in recent months. My work on public pension financing

argues that if we wish to strengthen State and local government

finances, we need an accurate assessment of the size of pension liabilities and the steps that will and won’t help the governments reduce them. Current pension accounting methods unequivocally fail

on this front.

To be clear, the so-called market valuation critique of pension financing is not a criticism of the average returns that plans project

for their investments. It does not say, for instance, that pension

funds will yield 7 percent on average rather than the 8 percent average they claim. Rather, it says that because this 8 percent is a

risky return, it is inappropriate to use that interest rate in valuing

benefit liabilities that are guaranteed by State law or constitutions.

Pensions current practice of discounting guaranteed liabilities

using returns on risky assets runs counter to economic theory, the

practice of financial markets and the accounting standards imposed

on private sector pension plans.

As the vice chairman of the Federal Reserve put it, ‘‘While economists are famous for disagreeing with each other on virtually every

other conceivable issue, when it comes to this one, there is no professional disagreement. The only appropriate way to calculate the

present value of a very low risk liability is to use a very low risk

discount rate.’’

Most economists believe that since pension benefits are guaranteed by governments, it is appropriate to discount them using interest rates derived from other government guaranteed investments, namely Treasury bonds. Using an appropriate discount rate,

current unfunded pension liabilities are not $500 billion, as

claimed, but over $3 trillion. Violating this rule, as public pension

accounting does, leads to nonsensical results.

For instance, public pensions could erase all their reported deficits and even generate a surplus if only they were to shift all their

investments to stocks and assume a 10 percent rate of return. Note

the plans actual benefit liabilities would be the same and the market value of their assets would be the same. But by adopting a

more aggressive funding strategy and ignoring the risks of that

strategy, they could magically generate $500 billion at the stroke

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of a pen. If this seems to make no sense, it is because it does make

no sense.

But even today, after the financial crisis and the market meltdown, many public sector pensions are effectively doubling down on

risk. Having already doubled the share of their assets going to

stock since the mid-1980’s, public sector pensions are now the largest single investor in hedge funds and are also moving into private

equity.

There is no coherent funding strategy that would use these assets to fund fixed guaranteed benefit liabilities. This is particularly

so when you note that the public sector pensions operate under a

standard called inter-period equity, which dictates that every year,

a plan should fully fund the benefits earned in that year and not

pass on liabilities to future taxpayers.

But when you fund a guaranteed benefit using highly risky assets, it is obvious that you are passing significant contingent liabilities on to future generations. The more risk you take, the larger

these liabilities are.

Using discount rates that economists deem appropriate, public pension unfunded liabilities are somewhere over $3 trillion. The

only way to reduce these unfunded liabilities would be to actually

fund them. Most States currently devote 3 to 4 percent of their

budgets to pension funding. Using more accurate accounting, that

would rise to over 10 percent, in some States significantly more so.

Simply taking more investment risk won’t do the trick, nor should

it.

We face difficult choices, but on one thing we should be clear. It

is more important to get the numbers right before you have a crisis, when you still have time to do something about it, than to wait

until a crisis has hit. It would be a sad irony if, even as we recover

from a financial crisis driven by lax accounting and excessive risktaking, that we lurched into a new one, driven by the same causes.

Thank you very much.

[The prepared statement of Mr. Biggs follows:]

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Mr. MCHENRY. I certainly appreciate your testimony. I will recognize myself for 5 minutes.

Mr. Kurtter, in your testimony you affirm that combining both

debt and pension metrics will improve transparency for investors.

Can you please name specific measures that States can adopt to

enhance transparency?

Mr. KURTTER. Thank you, Mr. Chairman. We published a report

recently, Combining Debt and Pension Metrics into one Metric, for

purposes of providing increased transparency to the marketplace

for purposes of evaluating credit risk. We did that because we were

trying to conform with practices in other business lines, the way

corporations are looked at and hospitals. Our goal is improved

transparency for the investors who rely on our ratings.

Mr. MCHENRY. What specifically could States do? In terms of

public policy, what can we do to enhance disclosures for investors?

Mr. KURTTER. We don’t advise or make recommendations.

Mr. MCHENRY. OK, then if that is your answer, that is your answer.

Mr. Prunty, would you answer the same question?

Ms. PRUNTY. We have looked at pension liabilities as pat of our

criteria for many decades. I think that the challenge, when you

look at public plans, is that the current governmental accounting

standards allow for a range of actuarial assumptions when they are

calculating those liabilities. So it is very difficult to do an apples

to applies comparison among States and among local governments

as well.

So we do report those liabilities and have reported those alongside debt, and give them equal weighting when we are evaluating

the debt and liability profile. But I think that some of the variability and the actuarial assumptions that are allowed definitely

make it challenging to do that kind of comparison.

Mr. MCHENRY. Would uniform disclosures assist in credit rating

and transparency for investors?

Ms. PRUNTY. I think there are current efforts underway with the

Governmental Accounting Standards Board to look at that issue.

We are obviously watching that closely.

There are a lot of unique features, as you go from plan to plan.

They are not uniform plans, government by government. So I think

that the one size fits all solution is probably a little bit challenging

there. But certainly, a little more uniformity would make it easier

to make comparisons across governments.

Mr. MCHENRY. Mr. Kurtter, would uniformity assist?

Mr. KURTTER. Yes. We are in favor of more uniformity and consistency and transparency across the marketplace in terms of repotting this information.

Mr. MCHENRY. Thank you. In comparison of the corporate bond

market to the muni bond market, is there more disclosure in the

corporate bond market than in the muni bond market? Ms. Prunty.

Ms. PRUNTY. When we are assigning ratings, we are generally relying on the information provided by issuers. Based on our criteria,

we are assuming that——

Mr. MCHENRY. If you don’t want to answer the question, it is

fine. I don’t have much time. Is there more disclosure, more transVerDate 17-JUN-2003 14:05 Oct 28, 2011 Jkt 000000 PO 00000 Frm 00062 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\68364.TXT KATIE PsN: KATIE
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parency in the corporate bond market than municipal bond market? Yes or no.

Ms. PRUNTY. Yes, I’ve been in public finance my entire tenure at

S&P, so I am not familiar with the corporate.

Mr. MCHENRY. Mr. Kurtter.

Mr. KURTTER. General disclosure or pension disclosure, Mr.

Chairman?

Mr. MCHENRY. Both.

Mr. KURTTER. Both.

Mr. MCHENRY. Or either. Whatever you would like to answer. I

am just trying to get an answer from you guys. And this is a beef.

I have to be honest with you. This is a beef with the credit rating

agencies, is you guys talk around the problem and actually not address it. This is the frustration that many of us have, and I think

the marketplace has with this.

Mr. Kurtter.

Mr. KURTTER. Yes. In corporate disclosure generally, there is interim financial reporting and other types of more timely reporting.

Municipal disclosure, the audits are typically often late, and there

is no interim financial reporting. That said, I think it is important

to recognize that in a public finance marketplace, there are many

resources of publicly available information that are not available in

the corporate world. Budget information, revenue reporting, things

that are publicly available as a consequence of the budgeting process.

Mr. MCHENRY. In terms of what has happened in Ohio, according

to municipal bond strategists, upon the recent passage of Ohio

State union reform legislation, the cost of borrowing reflected by

the yield of the State’s long-term general obligation bonds fell by

a meaningful percentage, and dropped the cost of borrowing for

Ohio, post-passage of this union reform legislation, basically the

collective bargaining agreement.

Mr. Kurtter, can you touch on this? Would you be willing to

touch on that?

Mr. KURTTER. The existence or non-existence of collective bargaining is not in and of itself determinative of budget balance or

the likelihood that an entity will acquire large unfunded liabilities

or large post-retirement liabilities. From our perspective, we look

at the bottom line, it is whether the budget is balanced rather than

how a budget is balanced.

Mr. MCHENRY. But it has a meaningful effect on the marketplace, though it didn’t create, change the rating, it did change the

rate that people were paying, the State was paying.

Mr. KURTTER. I don’t track the pricing, so I trust that is correct.

Mr. MCHENRY. With that, I recognize Mr. Quigley for 5 minutes.

Mr. QUIGLEY. Thank you, Mr. Chairman.

Dr. Baker, you are a little more optimistic on the overall picture

than some. And on the overall picture, that is probably accurate.

Wouldn’t you concede that for six to eight States on the pension

issue it is far more acute a problem and far more dramatic action

has to be taken?

Mr. BAKER. Thank you, Ranking Member Quigley. I am usually

not known for my optimism.

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You certainly do have several States, the ones you had mentioned on that list, that clearly have more serious problems. We

have a number of States that, had we not gone into the downturn,

their pensions would be pretty much fully funded. We had other

States that faced problems even prior to the downturn, and certainly the situation was made considerably worse by the downturn.

As you know, in your own State, Illinois, of course, they did have

a substantial tax increase in part to deal with those problems. I

suspect you will see comparable actions in other States.

Mr. QUIGLEY. But is that enough? Even Illinois is still borrowing

a significant amount of money to meet those obligations. Are you

suggesting, with all due respect, they could all be made up for with

additional revenue?

Mr. BAKER. I don’t mean to tell the States how they should deal

with their shortfalls. But I will say one thing that is front and center, is the state of the national economy. If it were the case that

we were somewhere near full employment today, Illinois and every

other State would see both a much better overall budget situation

and as well its pensions would likely look better, both because

there would be more money flowing into it, regular money flowing

into it. And then on top of that, I would anticipate the stock market moving back toward more normal levels.

Mr. QUIGLEY. Well, if we believe in collective bargaining, we

should also believe in collectively solving the problems. I guess

what I am trying to get you to is that it is not just the economy

or additional revenues. There has to be some meeting in the middle. At least some of these pensions, you would agree, have been

a little too generous, a little too out of synch with actuarials in

terms of when people start collecting, how long they collect, how

long they pay in, the COLAs that are involved.

Mr. BAKER. Well, a couple of points I would make on that. Pensions are part of an overall compensation package. There have been

a number of studies, we have done some at my center, a number

of other organizations around the country, academics have done

studies, looking at public sector compensation in general. The conclusion of the bulk of these studies, I know Dr. Biggs has opposite

conclusions, but the conclusion of the bulk of these studies is that

public sector workers are paid a little less, taking into account

their pension commitments, than private sector workers, adjusted

for education.

Now, having said that, are there cases where I think pensions

are inappropriate, where maybe workers are allowed to retire too

early, where they are perhaps structured inappropriately, it is common for pensions to just be based on the last 3 years or the last

1 year, I wouldn’t do it that way. But again, I am not setting the

laws for State pensions.

Mr. QUIGLEY. I agree. We are both in that situation.

Mr. Prunty and Mr. Kurtter, you seem fairly confident that we

are not in for a major default in the next year or so. But stranger

things have happened when the experts haven’t picked up. The

issue that I am most concerned with is the impact on the market

as a whole, even the bond market. Is there a contagion factor, if

a major State had a major default?

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Ms. PRUNTY. Thank you. We do, our current rating would suggest that we don’t see a default for Illinois, and actually their

bond——

Mr. QUIGLEY. Or any State.

Ms. PRUNTY. Yes, or any State. Illinois has actually, over the last

year, during the last legislative session, put some protections in to

ensure that there was sufficient special funds on hand in order to

cover future years’ debt service obligations, both short and longterm, and so have made some adjustments there in order to focus

on that.

Mr. QUIGLEY. But the question still stands. Given a possibility in

this country of a major default, is there a contagion factor? Or is

this all isolated in terms of how you rate funds?

Ms. PRUNTY. I think defaults historically, if you look at New

York City back in the 1970’s, there was a significant focus on the

market and the impact there. I think that is why you see so many

oversight mechanisms across States to prevent local government

from being in a default situation for exactly that reason, that there

would be concern that there would be implications for the broader

market.

Mr. QUIGLEY. Mr. Kurtter, quickly.

Mr. KURTTER. Yes, thank you. The markets clearly are very jittery right now. We don’t believe there will be major State defaults.

We don’t believe that there will be more than a few small rated defaults among local governments.

But clearly the markets are jittery, and any kind of a significant

default would add to the nervousness of an already jittery market.

Mr. QUIGLEY. Thank you.

Mr. MCHENRY. The gentleman’s time has expired.

Ms. Buerkle, for 5 minutes.

Ms. BUERKLE. Thank you, Mr. Chairman, and thank you to our

panelists for being here today.

My district is in upstate New York, so if you will indulge me, for

my 5 minutes I would like to talk about the State of New York,

and in particular because it is one of those 44 States that the

chairman spoke of in his opening remarks.

Dr. Biggs, I would like to just direct my question to you, and

then to Mr. Kurtter, and then if anyone else would like to comment

on it. In 1975, New York City found itself in a crisis and had to

make a decision between paying its debt or paying its employees.

As you know, they paid their debt down.

My question is, do you foresee New York State being in, facing

such a choice within the next 5 years? And if you could comment

on how dire you believe the situation is in New York at the present

time.

Mr. KURTTER. I know a little bit about New York State. My father is from upstate New York, near Schenectady, so I spent a bit

of time up there. I would not claim to be an expert on New York

State finances.

Certainly in the recent history, it has not been encouraging

there. New York State’s pensions have been better funded than in

many States of the country. But when you use honest accounting,

that is being the top of a very bad heap. But still, the other costs

the State government has to deal with are pretty significant.

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I have not followed closely enough the efforts of Governor Cuomo

there to try to rein in some of the costs and to bring balance to the

budget. If those are successful, certainly New York will be in better

shape. I think because of New York’s reliance on tax revenue from

Wall Street, which is highly cyclical, they have a risk factor there

that some other States may not have.

So certainly I am hopeful and more hopeful now than I was 6

months ago. But New York State has a long way to go.

Ms. BUERKLE. Thank you. Mr. Kurtter.

Mr. KURTTER. Yes. Our ratings really speak to whether or not we

expect the State to make good on its bond payments in full and on

time. That said, of course, the State has had very difficult problems, as all States have, are facing tremendous problems of managing their revenue and spending. Our view is that the States have

revenue and spending problems, but not really debt problems, because even in New York, their debt service is a relatively small

portion of their overall spending.

Right now, of course, because revenue is short, payments to the

retirement system and all other expenses are competing with each

other for scarce dollars. And the State is having to make difficult

choices about meeting, balancing their budget within the constraints of weaker revenue.

Mr. BAKER. Let me just quickly add to that, just to remind the

committee that first and foremost, the state of the economy will be

the most important factor determining the ability of New York and

every other State to meet its obligations.

Ms. BUERKLE. Thank you, Dr. Baker.

Senator.

Mr. LILJENQUIST. You asked the question whether or not New

York is in a situation where they need to pay their debt or pay

their employees. Utah is in that situation right now. As we ramp

into 75 percent increases in our employer contribution for pension

systems, that is going to pay for these losses. That is 10 percent

of our general fund that will not be available for wages or health

care benefits for our employees.

We fund things in this order in our State, and I think most

States are similar. We fund pension benefits first, health benefits

second, and whatever change is left over goes to wage. And our

wages in the State have fallen behind as we have struggled to keep

up with pension and health care costs.

So as we looked at our reforms, we started calling it, maybe

euphemistically, the wage liberation act. Because we said, look, you

can’t have a set bucket of money and having your benefits eat more

and more of that bucket of money. You have no money left for

wage.

So we struggle to get the 24 year old, at the start of his career,

because he or she is looking for wage, and benefits are less important. And we struggle to recruit, as a State. We think by affirmatively saying, and generous, our legislation says you get 10 percent

toward your retirement, 10 percent of your wage. If you are public

safety or fire, you get 12 percent. So it is a generous amount, but

it is set. And that is all we are doing. So hopefully over time, we

can repair wages for our employees, which by our data in the State

of Utah, their actual wage is lower because we are making this

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choice, do you pay this debt or do you pay the employees. And we

are struggling with that right now, as a State.

Ms. BUERKLE. Thank you. I yield back my time.

Mr. MCHENRY. Mr. Welch for 5 minutes.

Mr. WELCH. Thank you, Mr. Chairman.

Senator, congratulations on your success in making some

progress in dealing with this in Utah. You have to give us the

magic potion so we can make some progress here.

One of the things we are struggling with is our own deficit. And

the new majority is, in my view, rightly focusing on that. But there

are consequences to some of the policy decisions we make. I just

want to ask, I will start with Dr. Baker, what is the impact on the

States in their ability to address, among other things, this under

funding of the pension, if we have $100 billion in cuts that include

substantial revenues that the States have been depending on? Is

there an impact?

Dr. BAKER. I certainly expect there to be an impact, to some extent. These are revenues, as you say, that would be committed to

the States. But I think probably the bigger impact is that there

have been a number of estimates, Mark Zandi and Moody’s and

Goldman Sachs came up with estimates that this could lead to loss

of as many as 700,000, 800,000 jobs. This means more people unemployed, slower Economic growth, less tax revenue to the States.

I think that actually is likely to be the bigger impact, due to the

impact on the economy, than sort of direct impact in terms of cutting money to State governments.

Mr. WELCH. Thank you.

Mr. Kurtter, how about you? And again, these are policy choices

we have to make. There is not endless money. We here in Congress

have to bring us back to fiscal balance. But I also think we have

to be clear-eyed about the impact of some of these cuts, when it is

revenue that goes to the States, and then how that impacts their

ability to deal with their own fiscal problems. Do you have a comment on that question?

Mr. KURTTER. States are beginning to face the fiscal dilemmas

that they are challenged with right now. They are making very difficult spending and revenue cuts, touching programs that in prior

years were off limits. These are tough choices elected officials have

to make.

With regard to pension obligations, they are also beginning to address some of those issues, too, by increasing employee and employer contributions as well as addressing the benefit side of the

equation.

Mr. WELCH. Ms. Prunty, how about you?

Ms. PRUNTY. Yes, I think it is fair to say that the budget climate

is still very difficult for States. If there were any reductions in revenue sources, be it Federal or other tax sources, it would add additional difficulty to the current budget challenges. Particularly because Medicaid is a very large portion of State spending, and that

is the primary Federal flow of revenue to States. So yes.

Mr. WELCH. Thank you.

Dr. Biggs, I think you made a very compelling point in terms of

the investment models and what is realistic. You can’t have a pie

in the sky kind of projection.

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But on the other hand, is it equally questionable as to whether

there should be this so-called risk-free model that imposes what

historically I think is a much lower rate of return, where there are

consequences to State budgets if you have a so-called risk-free

model where you can give yourself the, perhaps satisfaction that

you ‘‘guaranteed’’ to have that return, but on the other hand, there

is a consequence with respect to how much then has to be put in

to fund it. It may be more.

Mr. BIGGS. Sure. Well, I think it is important to repeat that the

use of a riskless or a risk-adjusted discount rate is the way you

value your liability. It doesn’t restrict the plan, if it wishes to invest in equities or invest in more risky assets. And the plan will

benefit from those investments if they pan out. If they invest in

stocks and the stocks generate higher returns, then they actually

have more assets on hand than they otherwise would have.

The objection is to essentially assume that those assets will generate 8 percent returns going forward without taking any risk into

account. If you go back to the 1980’s, up to the——

Mr. WELCH. Let me just get clarification, because I think this is

quite important. If you have a riskless model where you are saying

it has to be the T-bill rate, let’s say, where there is some, we hope

the Federal Government is good for it, that can have a depressing

impact on the ability of a State to meet many of its other legitimate obligations, including what the Senator was talking about,

trying to bring up the wage scale.

Mr. BIGGS. Sure. If you value your liabilities correctly, the liability is what it is. How you fund a liability is an entirely distinct

question from what the liability is. Plans today, State pensions

generally take an aggressive funding strategy, which means they

invest in stocks and hedge funds, things like that. The higher expected return means they can make a lower contribution today.

And people like that. It leaves more money for other things.

But because the benefit is guaranteed, it means a higher contingent liability on future taxpayers. That is inconsistent with the

standards that GASB lays out that says, you should try to fully

fund your benefits as they accrue and not pass contingent liabilities. Well, what we are finding out today, again going back to the

mid-1980’s, before then you had a high level of funding into State

pensions, but conservative investments to go into them. They would

invest mostly in bonds and things like that.

That meant you had to put a lot of money away. You didn’t have

a large contingent liability. Since then, they went more aggressively into stocks, which essentially cut their funding levels in half.

For many years, you had good times. The stocks returned well,

they increased benefits, they had funding holidays. Today we are

seeing the flip side of that strategy.

So you can’t take an aggressive, risky strategy and expect that

you are never going to have to deal with the downside. That is currently what we have.

Mr. MCHENRY. The gentleman’s time is expired.

Mr. Meehan of Pennsylvania, for 5 minutes.

Mr. MEEHAN. Thank you, Mr. Chairman.

Thank you to each of the panelists for your articulation of a lot

of details on a very, very challenging issue, certainly for those who

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struggle at the local level. I often think about these things in the

context of municipalities, not just the States, where there is a

greater capacity to handle these, but a lot of local obligations that

have been undertaken for everything from funding local economic

development to other kinds of programs.

I am thinking about the implications that are going to be sort of

bleeding down, particularly as we aren’t able to predict yet what

States are actually going to be doing with their budgets. But the

implication is that much of it is going to be pushed down to the

local level as well.

I think Ms. Prunty and Mr. Kurtter, you discussed this issue,

which I don’t clearly understand, which is the role of accounting in

municipal finance, which may be different from what we do with

a publicly traded company. And the fact that we may be understating the risk, because of the method of accounting. Can you explain to me what the difference is between municipal accounting

and accounting that is done, say, for a corporation, and their tax

filing?

Ms. PRUNTY. I think on the Governmental Accounting Standards

Board side, there is a different government, I think there is a recognition that they are different from corporations, because they are

going concerns, and it is unlikely that they will be out of business

going forward. So the Governmental Accounting Standards board

does allow a different set of assumptions to be used for public pension accounting. And that has been the case. There is significant

discussion underway at the Governmental Accounting Standards

Board to look at that and determine if that is still appropriate,

given market performance of the last decade.

But I think that the accounting differential really recognizes the

fundamental difference between governments and corporations.

Mr. MEEHAN. Is it exclusive to pensions, or does it involve other

kinds of general obligation bonds as well?

Ms. PRUNTY. The Governmental Accounting Standards Board

also covers the annual financial statements or financial audits that

governments provide. So there is a differential in accounting standard there, also, recognizing some of the differences between corporations and governments.

Mr. MEEHAN. If it is understated, and that was the testimony,

I believe it was you or Mr. Kurtter, was there somebody that testified today that local, there is sort of an understatement of the problem? Dr. Biggs, you did. Would you then answer my question?

Mr. BIGGS. The standards used by the Governmental Accounting

Standards Board [GASB], allows States or municipalities to discount their liabilities at the expected rate of return of any assets

they have set aside to fund their liabilities. So if they think their

assets are going to return 8 percent, they can discount the liability

at that. That applies mostly to pensions. It would apply in some

limited cases to retiree health care. Some States pre-fund their

health care obligations. Most don’t.

So in the private sector, a private sector pension plan could discount its pension liabilities at the rate of return or the yield on corporate bonds, which are currently around 51⁄2 percent. So the effect

of the differences in the discount rates is really very, very large between the private sector and the public sector.

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Mr. MEEHAN. Thank you for that explanation.

I just have one remaining question. Mr. Kurtter, let me ask you

this one. In my review for this hearing, there was a discussion

about the fact that the Federal Reserve looks as if they are going

to decrease their participation in the purchases within the bond

market. Do you have any sense as to what impact that is going to

have on the interest rates, and a prediction about how high those

interest rates may go?

Mr. KURTTER. Yes, Mr. Congressman, that is really something

that is really outside my area. I am a State and local government

analyst, and I don’t really have an opinion on these kind of larger

macro issues.

Mr. MEEHAN. OK. Is there anybody on the panel that does have

a feeling on that issue?

Mr. BAKER. Well, the consensus, if you look at the Congressional

Budget Office, and just about every other forecaster out there, is

that the interest rates will head upward. They are extraordinarily

low levels today. Assuming that we do see some sort of economic

recovery, it is reasonable to expect that they will get to more normal levels.

Mr. MEEHAN. Thank you.

Mr. MCHENRY. With that, I yield the full committee ranking

member, Mr. Cummings, 5 minutes.

Mr. CUMMINGS. Thank you very much, Mr. Chairman.

I want to thank our witnesses for your testimony.

Dr. Baker, one of my concerns in having been now in State legislature for 15 years and been here on the Hill for 15 years, you see

a lot of times folks trying to deal with a problem as if that problem

is going to last forever. And they deal with it, and then things get

better.

When I listen to a lot of the discussion, I am worried about folks

who, when the economy comes back, we try to make these changes,

and it will be hard to reverse it. Do you follow me? Is that one of

your concerns, too?

Mr. BAKER. Absolutely. Again, I was on the other side of this argument a few years back, because I did feel that given price to

earnings ratios in the stock market in the 1990’s, particularly when

we had the bubble, that pension funds, both on the private and

public side, were being hugely over-optimistic. Now, we have a serious downturn. Much of the pension fund shortfall likely will go

away when we get future year valuations, because of course, the

market has recovered much of its lost ground.

I am not saying it is going to go away 100 percent. But we are

looking in many cases at funding periods that were very near the

trough of the market. Now, there is averaging, so it is a little more

complicated than that. But we are in many cases looking at funding periods that were near the trough of the market. The market

has recovered much of its value. I don’t have a crystal ball, so I

can’t tell you it will recover all of its value. But it is almost certainly going to be the case. They will look better simply from that

recovery.

Again, if we had the economy back on its feet, if we were back

near 5 percent unemployment, we would be looking at a much better situation in general for State and local governments. So the

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idea that we are going to be in perpetual crisis, I can’t roll that out.

But I think that is going to be more determined by the situation

of the macroeconomy than the finances of State and local governments themselves.

Mr. CUMMINGS. That leads me to my next question. Probably the

most poignant example of how politicians use pensions and public

employees as their scapegoat is the battle that has transpired in

Wisconsin on this issue. As a February 22, 2011 Huffington Post

article explains, it says, ‘‘While Governor Scott Walker has painted

a dire picture of his State’s pension obligations, Wisconsin’s pension fund for public employees is among the Nation’s strongest, according to a report by the non-partisan Pew Center. The Pew Report issued last year concluded that Wisconsin is a national leader

in managing its long-term liabilities for both pension and retiree

health care.’’

Dr. Baker, according to that same article, Governor Walker used

his State’s pension obligations to argue for a need to revoke collective bargaining rights of State employees. I am just wondering if

you had an opinion whether such a drastic step was necessary, or

was that an example of a scare tactic that you have discussed in

your report of February 2011, entitled The Origins and Severity of

the Public Pension Crisis?

Mr. BAKER. I won’t claim to be an expert on either Wisconsin’s

funding or Governor Scott’s motives. But I will say from what I

know of its funding, it is very close to fully funded. They have been

very responsible. And I will point out that again, just to be as clear

as I can here, pension is part of the overall compensation. There

have been analyses specifically of Wisconsin’s compensation packages. Jeff Keefe, at Rutgers University, looked at it and found that

public sector workers receive somewhat less total compensation

than comparably educated, experienced private sector employees.

If you are to cut the pensions in some way, you could no doubt

in the short term save some money. But workers expect comparable

pay. If you are reducing public sector compensation, you could either say, well, maybe we won’t get good workers in the future, or

alternatively, maybe you will have to make that up in other pay.

And again, the defined benefit is very important. Workers value

that certainty. And again, this gets back to this issue Andrew was

raising, that States can bear the risk. If you have a downturn and

there are 2, 3, 4 years where the market is down, where things

look bad, States can get through that risk, as long as they have in

general been responsible.

If you or I retire and the stock market is down, we are out of

luck. There is nothing we can do about that. So by virtue of taking

that risk, that is a very big benefit for workers, that they are willing to give up other compensation for. We would lose that if we end

defined benefit plans.

Mr. CUMMINGS. One of the things, when you talk to workers, particularly ones in my district, they tell me that when they were voting for various, during union negotiations, that they took less pay

because they were worried about the benefits when they retired.

Mr. BAKER. It is very common. Public sector workers have lower

pay by almost every measure than private sector workers, straight

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wages. But they have somewhat better pensions and health care

benefits.

Mr. CUMMINGS. Thank you, Mr. Chairman.

Mr. MCHENRY. The gentleman’s time is expired. And with that,

I recognize the full committee chairman, Mr. Issa of California.

Mr. ISSA. Thank you, Mr. Chairman. Thank you for holding this

important hearing.

Dr. Biggs, we have a constant debate, it seems, on public and private sector activities, union, non-union. The ranking member went

on quite a bit acting as though it is a scapegoat. Don’t we have basically a difference between unionized private sector workers and

public workers, particularly in that, in the private sector, a unionized worker is in Social Security, while in the public sector, at all

the State levels, virtually, they are in a system that has their high

pay opted out of Social Security and often Medicare, which means

they are out of a system and into their own system, which is not

fully paid for.

As I think Dr. Baker made very clear, they have this safety net,

which is current overseers, the elected officials and/or the elected

representatives, can make a deal that ultimately they know cannot

be kept in the future without unrealistic expectations of growth in

their bonds. Typically in California they were assuming a growth

that you could not find in any index, but you could find it for a

short time in PERS and STERS. Would you like to give us a little

insight into that part of the problem we are dealing with in these

pensions?

Mr. BIGGS. Well, this I think is an important issue, because one

question, how you resolve some of these pension financing issues,

comes down to your perceptions of how well or how poorly paid

public sector employees are. You are right that many public sector

employees don’t participate in Social Security. That is sometimes

pointed out as though they are losing something in that regard. I

don’t want to downplay the important protections that Social Security provides. But as a general deal, public sector pensions are a

far better deal for them. Social Security would pay them on average a rate of return of around 2 percent of their contributions.

Under the typical public sector pension, they are effectively guaranteed a rate of return around 8 percent. Compound that over your

full career, and it is an enormous difference.

You also tend to get, in the State and local sector, retiree health

care, which can be very generous, and often that is not included in

the private sector. Congressman Cummings was just mentioning

employees in Wisconsin. I know Milwaukee teachers, for instance,

receive retiree health care that is worth around 20 percent of their

pay. The sort of pay studies we have heard about today saying that

State and local employees are underpaid, it doesn’t include retiree

health care. It also tends to undercount the pension benefits they

get.

So we want to get a good feel for where things stand. We have

to compete for workers with the private sector. If you are in any

low level of government, you don’t want to underpay people. But

it takes careful analysis to be able to tel whether they are being

fairly paid or not.

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To touch on your last point, the assumptions that go into the

pension financing and things like this, I focused on the assumed

rate of return, and that is the most important one. There are many

other things that can be jimmied around. Illinois had some problems where they would cut benefits for workers that haven’t even

been hired yet and book those savings today. There have been examples in Washington State where their actuary said, you have to

better account for the longer work lives of people, and the board

said, no, we are not going to do it.

Mr. ISSA. And I am going to cut you off, I apologize. It is a good

train of thought, and certainly in San Diego, we have a scandal

where that has been well codified in criminal prosecutions.

Dr. Baker, I saw you startled when I talked about the unrealistic

expectations of the growth in PERS and STERS and so on. I heard

you say earlier, with the ranking member that, well, the markets

have come back. But isn’t it true that if you were broadly invested,

you in fact over the last 3 years had effectively net zero? And net

zero is 24 percent compounded less than the anticipated amount

that these contributions were based on. Can you sit here today saying that anyone on this side of the aisle should have confidence in

these retirement plans, if they assume 8 percent growth rather

than, let’s just say, inflation plus 1 or 2?

Mr. BAKER. I don’t think there is anyone who has been more critical of overly optimistic returns in the stock market than I am. And

I base that on price to earnings ratios. They were very high in the

1990’s. They were still somewhat high in the last decade. They

have fallen a great deal. Future returns depend on current price

to earnings ratios. Now that the price to earnings ratio is considerably lower, if you look out over a 20, 30 year horizon, then yes, I

could look to your side of the aisle and say yes, I think those returns are very reasonable, and have done the arithmetic.

Mr. ISSA. OK, well, I hope you are right. Let’s do another half

of this. Dr. Biggs, back to you for a second. We have historically

low interest rates today. We have a huge, ballooning Federal deficit, but my own State of California and many others have built up

a lot of debt. What happens if we return to, if you will, somewhere

between where we are today and where we were in the 1970’s?

What happens to both the Federal and the States’ ability to meet

pension obligations?

Mr. BIGGS. The Federal budget, and to a degree, the State budgets, have benefited from the fact that our financing crisis, our

budget problems, have coincided with significant financial problems

overseas, which has pushed capital from foreign countries into the

United States. That has helped keep our interest rates low. We are

very advantaged by virtue of that.

If interest rates start rising back to normal levels, or if they go

even further, if markets are not convinced of our ability to get on

top of our deficits, then all of this process starts cascading and it

happens much, much sooner than we otherwise anticipate. The history of financial crises, whether you are talking about currency crises, banking crises, is they can continue going on normal. But

when they happen, they happen very, very quickly.

So I think it is very good and we are very lucky to have low interest rates today. We should not be complacent because of that.

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Mr. ISSA. Thank you. I yield back.

Mr. MCHENRY. Thank you, Mr. Chairman. I will now recognize

Mrs. Maloney for 5 minutes.

Mrs. MALONEY. First of all, I want to thank the chairman for

holding this, and the ranking member.

We are going to the floor shortly on a budget vote to continuing

resolution. And in the budget proposals that have come forward for

fiscal year 2012, practically every, 42 States have proposed to

spend less on education and health care than they spent in 2008

after inflation. States are proposing these cuts, despite the fact

that the costs associated with their services will be higher.

So given that backdrop, I would like to ask Mr. Baker, why is

it important at this time not to cut Federal funding for State and

local governments?

Mr. BAKER. Again, I would say there are two reasons here. One,

perhaps the more important, is the macroeconomic reason, that at

this point the Federal deficit is supporting the economy. If we were

to radically roll back the Federal deficit in 2011, we would see less

demand. I don’t know of any story I could tell whereby if we cut

back spending, laying off public employees, we are going to see retail stores, hospitals, whoever it might be, go out and hire more

workers. I don’t know a story of an economy that works like that,

at least not when you are in the middle of a downturn.

So the macroeconomic picture is very important. The other part

of the story is, obviously, many of these programs have the character investment, we are talking about education. If our kids don’t

get adequate education, because we have 1, 2, 3 years of economic

slump, they are not going to be able to make that up. Some of the

cuts are in regulatory programs, like the Securities and Exchange

Commission, I would think people would be very sensitive to that,

recognizing that we clearly had problems of inadequate regulation.

We were talking about fraud in the public sector or at least questionable accounting. There clearly was a serious rash of that in the

private sector as well. I would think that Congress would be very

sensitive to that.

So I think we could pay a big price for it.

Mrs. MALONEY. Well, isn’t it true that proposed GOP cuts to Federal funding for State and local governments will force some States

to impose higher taxes and to cut vital public services, actions that

will hinder economic growth? Could you comment on that?

Mr. BAKER. Most States in the country are facing serious budget

shortfalls. They are making cutbacks in a wide range of areas, and

many of them are raising taxes as well. One could argue as to how

vital those are. But clearly, they are making important cutbacks,

and I think most, even the Governors that have been aggressive in

supporting those cutbacks I think regret many of them in the sense

that they feel they are cutting back services that have real merit.

And again, this is not the time, I would think, that you would want

to see cutbacks in programs that, say, provide health care for the

poor. Because there are more poor now, and it is very hard to

argue that they could simply go out and get a job, when we have

close to 25 million people unemployed or under-employed.

Mrs. MALONEY. And Mr. Baker, how will State and local governments balance their budgets, without this much-needed Federal

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funding? Many States have budget gaps that are huge, including

my own State, including the great State of California and others.

So how in the world are they going to balance their budgets?

Mr. BAKER. Well, nearly every State has requirements that they

balance the budget. There is always some room around that. But

in most States, this will mean serious cutbacks in spending and/

or increase in taxes, which again, this is not the sort of thing you

want in the middle of a downturn. If we were in a situation where

the economy were at normal levels of output, we were operating

near 5 percent unemployment, you could say, OK, fine, the private

sector will pick up the gap. But I don’t think credibly can tell that

story, given where the economy is today.

Mrs. MALONEY. I want to thank you for your testimony and just

conclude by saying that State and local governments have eliminated 426,000 jobs since August 2008, and State budget cuts have

eliminated additional jobs in the private sector. In fact, at least 13

of 42 States who have released budget proposals for fiscal year

2012 have proposed layoffs and cuts in pay for public workers, and

8 States have proposed measures such as extending expiring tax

surcharges, repealing tax credits or deductions and broadening the

base of some taxes, and raising rates. We have been called for a

vote, on that sort of depressing note.

Thank you all for your testimony and for being here today.

Thank you.

Mr. MCHENRY. Thank you for yielding back. With that, I recognize Mr. Ross for 5 minutes.

Mr. ROSS. Thank you, Mr. Chairman. I will try to be brief.

I am trying to get my hands around this. It appears even though

we have had a reduction in work forces, both federally, State-wide

and in municipalities, there still exists an unfunded mandate, or

an unfunded liability out there, with regard to the defined pension

plans. Ms. Prunty, what I am trying to understand is, at some

point, as a financial rating organization, you have to look at these

pension plans and say, it is too good to be true. You have to look

at the investments that they are making in order to fund these,

correct?

Ms. PRUNTY. When we are analyzing pension, we do include pension in our review. It is part of our criteria and has been. We look

at all of the underlying assumptions, we look at the liabilities, and

it is factored into our rating. You will see a differential, for instance, Utah is a triple A rated State. They have very proactively

managed those liabilities and looked at their assumptions. You do

see us factoring in——

Mr. ROSS. They have looked at it and made adjustments moving

away from defined benefit plans, is that correct?

Ms. PRUNTY. That is part of the solution in Utah. But that is not

universal across governments. Most of the pension plans do remain

defined benefit.

Mr. ROSS. In your statement you say, in general, we believe

worst case scenarios regarding pensions will occur only if governments are unable or unwilling to use their powers of adjustment.

What would you recommend to be their powers of adjustment in

order to avoid the worst case scenarios?

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Ms. PRUNTY. I don’t think we would have a recommendation on

what the power of adjustment is. But I think history has shown

that they have the ability to either manage the liability side of the

equation or increase contributions or make other adjustments to

the overall program and plan. So those are really policy choices

that each individual State or local Government will make.

Mr. ROSS. Moving from a defined benefit plan to a contribution

plan would be a step in the right direction, would you not agree?

Ms. PRUNTY. I think that we would say that those are, again,

policy decisions that each government is going to make on, and we

will look at the overall impact on the liabilities.

Mr. ROSS. But from your perspective, from your financial rating

perspective, it would be more advantageous to a better rating if it

was a contribution plan?

Ms. PRUNTY. I think proactively managing liability is certainly

very positive. And making a strong commitment to funding the

pensions has historically been consistent with a high rating level.

Mr. ROSS. Mr. Kurtter, I want to go to you for one quick second,

because you also are in the financial rating business. If, as the title

of today’s hearing implies, bailouts on private and public programs,

if there were ever to be a bailout, would that not be an assumption,

then, that a financial rating service would have to take into consideration when giving a rating, once the precedent is set?

Mr. KURTTER. Our ratings don’t assume that the Federal Government will bail out States. We do assume that——

Mr. ROSS. But let’s assume that it is done, that a bailout is actually done.

Mr. KURTTER. What we do consider is that the Federal Government has always and by law assumes the cost of emergency response in the event of natural disasters and other man-made

events. We do build that into our ratings.

Since the role of the Federal Government in providing bailout, if

a State were to need assistance, is uncertain, we don’t embed that

in our ratings, because we don’t have enough precedent to reliably

know that investors could depend on that.

Mr. ROSS. It would seem to me, though, that once a precedent

is set, then it would have to be considered as a potential assumption in making your ratings.

Mr. KURTTER. A precedent is situationally based, and may be a

relative particular circumstance that may not be something we

could rely on in the future.

Mr. ROSS. Dr. Biggs, one thing real quickly. Mr. Kurtter points

out we do not expect any States to default on their bond obligations

in the next 12 to 18 months. Do you agree or disagree with that

statement, and why?

Mr. BIGGS. I wouldn’t want to overstate my confidence in this

area, because it really depends on State by State knowledge. It is

also extremely difficult to predict low probability events. If we had

defaults every year, we would have very good models for knowing

what leads to a default. At this point, they are so infrequent it is

hard to say. So I think I would agree, but it is certainly not something I would be complacent about.

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Mr. ROSS. OK. And Senator, last question. Given the bad results

of many revenue bond projects, should such highly risky projects

benefit from tax exemption?

Mr. LILJENQUIST. Pardon me?

Mr. ROSS. On municipal bonds, should we continue to have taxexempt municipal bonds, or should Congress come into play and

say, hey, wait a second, these things are so risky, there is such a

high rate of default, we are incentivizing the sale of them with tax

exemption, should we as Congress step back and say, you know

what, maybe we should readdress the tax-exempt status of these

things?

Mr. LILJENQUIST. I think that is a good question. I think the

challenge we have more with our municipalities is having them

over-extend themselves, because of the free ability of credit. We are

addressing that in our State ourselves, trying to make sure that

our cities aren’t over-extending themselves. We end up being the

catch-all for them, so that is something to consider.

Mr. MCHENRY. The gentleman’s time is expired.

With that, I am going to recognize the vice chair, Mr. Guinta

from New Hampshire, for 2 minutes, and then Mr. Walsh for 31⁄2

or 4 minutes, depending on the time for the votes on the floor. Mr.

Guinta.

Mr. GUINTA. Thank you, Mr. Chairman. Thank you all for being

here. I will be very brief, because we do have to go over to vote.

A question for Dr. Baker. First of all, do you feel, generally

speaking, that the Federal Government should be backing the

loans that States are asking for and demanding for their borrowing?

Mr. BAKER. I am afraid I am not sure which loans you are referring to.

Mr. GUINTA. The Build America bonds program.

Mr. BAKER. Oh, I am sorry.

I think a program like that is a reasonable program. One could

construct different contours to it, sure. But I think given the situation where we are in the economy, I think it does make sense for

the Federal Government to encourage States to engage in infrastructure spending, stimulus of different types. We do need to boost

the economy.

Mr. GUINTA. And for the edification of the committee, what is

your opinion as to where the Federal Government gets that money

from?

Mr. BAKER. Given that we are in a downturn right now, that

would mean borrowing. I don’t think there is any doubt about if

you were to raise taxes, it would be self-defeating.

Mr. GUINTA. OK, so the Federal Government is borrowing the

money to give to States so they could borrow to pay whatever obligations they have. I hope that they are not doing it for, I would

accept that it would be capital-based projects and things of that nature. But I have seen some States borrow to pay their operating

costs, which is obviously not a good thing to do, but I have seen

it.

I guess my question would be, this Build America Bonds program

is expiring, correct?

Mr. BAKER. That is correct.

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Mr. GUINTA. Does that have a negative or a positive effect on,

from a rating agency perspective, for the States that are using,

that have used that program?

Mr. BAKER. Did you want me to answer that question?

Mr. GUINTA. Sure.

Mr. BAKER. If they reduce their borrowing, if they are no longer

borrowing because the program is not there, I imagine it would be

pretty much neutral.

Mr. GUINTA. Would Ms. Prunty or Mr. Kurtter agree with that?

Where is there an effect, now that this program is lapsing?

Ms. PRUNTY. The Build America Bond program has, the expiration has hit the end of the year. So I think that the Build America

Bond program was helpful in expanding the market for municipal

bonds. But it wasn’t a direct credit issue for State and local governments.

Mr. GUINTA. OK, thank you.

Mr. MCHENRY. With that, I recognize Mr. Walsh.

Mr. WALSH. Thank you, Mr. Chairman.

Dr. Biggs, I was going to ask you a few questions about my home

State of Illinois, but we have to vote, so I won’t. Let me just ask

you one quick big picture question. It has been suggested by the

other side, I think, that Government spending cuts, maybe even

cutting some public sector jobs at the State and local level, might

do some harm to the economy, might do some harm to the private

sector economy. Just give me your view. Does that make sense to

you?

Mr. BIGGS. There has actually been a range of studies that have

been done by international organizations, like the IMF, the World

Bank, the OEC, that have looked at countries that have successfully balanced their budgets. There are some who have tried and

failed, some who have tried and succeeded. The countries that tried

to balance their budgets and succeeded in reducing deficits and

debt did it principally on the spending side, I guess around 85 percent on average spending, only around 15 percent tax increases.

And those countries tended to focus on reductions in transfer

spending and reductions in what is called the government wage

bill, which is the size and pay of the government work force.

One thing that these studies have found, and there is some debate, but the worst case they found was that these sorts of steps

tend to be neutral with regard to the economy. Tax increase they

founded tended to hurt the growth of the economy. Some studies

have found that these steps could even improve economic growth

because of the confidence factor they build in. The individuals and

businesses and financial markets see the government getting on

top of these tough problems. And even if they are long-term solutions, they feel better today and that helps get the economy going

again.

Mr. WALSH. Great, thank you. Just one other quick question.

Senator Liljenquist, what is one quick takeaway? What can the

rest of the country learn about Utah, if you can bestow one lesson

on all of us?

Mr. LILJENQUIST. I think the lesson would be that reality is not

negotiable. If you can look forward and see what are bearing as a

State, which is what we did on pension problems, it didn’t pass the

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smell test. We looked at every scenario. And that was 95 percent

of the battle, as we went person by person in our legislature, and

sat down with them and showed them the data.

We are burying far more risk than we ever dreamed. And I think

that is the message, that reality is not negotiable. You have to do

something.

Mr. WALSH. Great, thank you.

Mr. Chairman, I yield back.

Mr. MCHENRY. I appreciate the gentleman yielding back. I certainly appreciate the testimony today.

Mr. Kurtter, in particular, thank you for being forthcoming. Your

analysis, that is very helpful. We wanted to have that from the

credit rating agencies.

I appreciate everybody taking the time to travel to Washington.

I know it is not easy to go before a committee like this, but thankfully it was brief in comparison to some other hearings, because we

have been called to the floor for votes.

We certainly appreciate your analysis. This is certainly an ongoing series, and we want to have feedback on what is necessary for

us to have accurate transparency and disclosure in the marketplace, so that, actually, those participating, those lending money to

States, will have the transparency they need to actually make an

accurate decision and price risk. That was obviously the center part

of this hearing. We certainly appreciate your testimony. We understand there is a challenge out there, the magnitude of which, there

has been a little debate. But there is a problem, and we have to

tackle that.

Thank you for your testimony. This meeting is now adjourned.

[Whereupon, at 3:11 p.m., the committee was adjourned.]

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