• Thoughts on the Market

Fixing a Hole (in State Budgets)

With Michael Zezas U.S. Public Policy Research for Investors

The hole in U.S. state budgets caused by coronavirus-driven revenue shortfalls will likely affect more than just muni bond investors. Head of Public Policy Michael Zezas explains.

In this Thoughts on the Market series, Michael Zezas offers perspective on how U.S. public policy affects equity and fixed income markets, including trade tensions, infrastructure and government policy. Listen to this week’s update.

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Current Episode Transcript

Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research of Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, May 6, at 11:00 a.m. Eastern.

Last week, we assured muni investors that states aren't about to go bankrupt. That's still true this week, but the hole in state budgets can impact investors beyond the muni bond market, both negatively and positively.

We're forecasting state budgets will fall short of expected revenues by about $180 billion and as much as $375 billion if the economy doesn't bounce back to positive growth in the third quarter of this year. States can bridge some of that gap through spending freezes and using reserves but barring a big enough aid package from the federal government, we'd still expect cuts in spending and employment.

For the economy, that means that the state and local sector is likely to drag on GDP growth, even as the private sector rebounds. Consider that about 75% of the state and local contribution to U.S. GDP comes from government employee compensation.

For the equity market, this hurts some sectors and helps others. The machinery and construction sectors will likely see less revenue from state and local capital spending, which accounts for about 90% of the nonresidential construction spend in the U.S. But state budget gaps aren't all bad news for investors. For example, there's a silver lining for the gaming sector. States needing revenue may increasingly look to unconventional sources, and legalizing and taxing online gaming could be one of those, opening up new markets to the sector.

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