By: Russ Kamp, CEO, Ryan ALM, Inc.

That famous phrase from the movie Apollo 13, is actually modified from the original comment spoken by Jack Swigert, the command module pilot, who said, “Okay, Houston…we’ve had a problem here”. In any case, I am not referencing our space program, the City of Houston or for that matter, any other municipality. However, I am acknowledging that we continue to have an issue with how the debt of companies, municipalities, and other government entities get rated and how those rating agencies get compensated.

There was a comment in New Jersey Spotlight News (a daily email newsletter) that stated “New Jersey is facing uncertain economic times, to say the least, but its state government got a vote of confidence from Wall Street this week.” Of course, I was intrigued to understand what this vote of confidence might be especially given my knowledge of the current economic reality facing my lifelong state of residence. It turns out that Moody’s has elevated NJ’s debt rating. Huh?

Moody’s action in raising the rating to Aa3 follows a similar path that S&P took several months ago. Yes, NJ was able to recently close its budget gap by $600 million through tax increases but given that the state has one of the greatest tax burdens of any U.S. state, the ability to further raise taxes is likely significantly curtailed unless they want to witness a mass exodus of residents, including the author of this post!

According to Steve Church, Piscataqua Research, a highly experienced and thoughtful actuary, “New Jersey’s public employees, teachers, police and fire systems are $96B underfunded by reference to their actuaries’ contribution liability calculations and $154B underfunded using their actuaries’ LDROM calculations!” Ouch! Furthermore, they offer an OPEB that is funded at <10%. In addition, New Jersey, like many states, will be negatively impacted by the cuts in Medicaid and other social safety net programs. These cuts are likely to put significant pressure on the state’s budget, which has already risen significantly in just the last 5 years from $38.3 billion in fiscal year 2020 to nearly $60 billion today.

So, how is it possible that NJ could see a ratings increase given the significant burden that it continues to face in meeting future pension and OPEB funding, while also protecting the social safety net that so many Jersey residents are depending on. Well, here’s the rub. Rating agencies are paid under the practice called “issuer-pays”. This process has often been criticized, especially during the GFC when a host of credit ratings were called into question. Unfortunately, few alternatives have been put into practice today. How likely will a municipality or corporate entity pay an agency for a rating that puts the sponsor in a poor light? We’ve been extremely fortunate to have mostly weathered recent economic storms, but as history has shown, there is likely another just around the corner. How will these bonds hold up during the next crisis?