Independent Thinking^®

Making Do: Federal Shutdowns, States and Municipalities

Federal shutdowns may be no way to run a country, but at the state and local level, governments generally make do. At present, municipal bond issuers are in generally good financial shape and should be able to weather the inevitable next shutdown, unless it drags on.
 
In the wake of the last near shutdown, averted in the eleventh hour on November 14, 2023, by a bipartisan vote to keep the government open until early January, it’s worth reviewing why shutdowns happen in the first place.
 
Government shutdowns occur when policymakers fail to enact legislation to fund the federal government by the end of the fiscal year, on September 30. Each year, Congress must pass, and the President must sign, legislation to provide funding for most government agencies. That legislation comes in the form of 12 appropriation bills, one for each appropriations committee. Lawmakers may also choose to pass a temporary funding bill, known as a continuing resolution, or CR, to provide funding for a limited time. If lawmakers fail to pass some or all of the appropriations bills on time, and a continuing resolution is not in place, the government shuts down, in part or in full.
 
The deadline has not been fully met since fiscal year 1997. Instead, lawmakers have come to rely heavily on CRs – temporary, imperfect solutions that avoid the difficult but necessary work of allocating funding. Lawmakers often enact multiple CRs in a single fiscal year before deciding on full-year funding levels. For fiscal years 1998 through 2024, 132 CRs were enacted.
 
Unlike a breach of the U.S. debt ceiling, for which there is no precedent, there have been 14 shutdowns since 1981, four of which lasted for more than a day, with the longest full shutdown lasting 16 days in 2013. The 35-day shutdown in 2018-2019 was considered a partial shutdown, as Congress had already enacted five of 12 appropriation bills, including funding for the Department of Defense and the Department of Veterans Affairs, which are the largest federal employers.
 
Programs categorized as mandatory spending, including Social Security, described by John Apruzzese in his article, Watching the U.S. Debt: The Implications for Investors, Medicare, and Medicaid, are not subject to protection, hospital care, air traffic, law enforcement and power grid maintenance workers, along with some legislative and judicial staff, can also be categorized as essential, meaning that they must stay on the job during a shutdown. Federal workers will likely get back pay once a shutdown ends, as they have in previous government shutdowns. However, private contracting companies serving the federal government could be forced to suspend operations and not receive back pay.
 
While a brief shutdown should not affect state and local budgets, a months-long spending pause could. Should it drag on, government leaders may have to decide if they want to use state funds to replace missing federal dollars and keep certain government services running. While states are in a much better financial position to keep programs going than in the previous extended shutdowns, their rainy-day funds could eventually run dry.
 
State and localities administer most federally funded social programs for low-income households; that money stops flowing when the government shuts down. In prior shutdowns, states have kept most programs and services running and later been paid back by the federal government. But sometimes they aren’t fully or quickly reimbursed.
 
Certain states that have federal lands or high concentrations of federal employees will feel the impact of a federal shutdown the most. After the threat of a shutdown in September, the governors of Arizona, Colorado and Utah announced that they will pay to keep national parks open in the event of a shutdown to avoid any loss of tourism spending. Base personnel in military communities are required to work, but they will stop receiving the support they rely on, including a paycheck, childcare, and the already financially challenged USDA Special Supplemental Nutrition Program for Women, Infants and Children.
 
A shutdown would halt federally required environmental reviews and reviews of grant applications for funding from the Infrastructure Investment and Jobs Act, or IIJA. Rulemaking for the IIJA and the Inflation Reduction Act may also pause. Commercial airports could also be affected, as a shutdown could disrupt the training of new air traffic controllers, who are already in short supply.
 
While a shutdown could cause problems for some of the most vulnerable members of society that are reliant on federal aid, these programs could be temporarily supplemented by ample state financial resources. An extended shutdown could also delay many capital projects due to the intricate federal approval process that is necessary to proceed.
 
Overall, we do not anticipate a significant credit problem in state and local bonds. Our clients hold a range of municipal bond enterprise systems in their portfolios. Of these sectors, mass transit has the potential for the greatest disruption due to an extended government shutdown. Mass transit systems, still recovering from declines in ridership during the pandemic and the loss of farebox receipts, are vulnerable to potential losses in federal funds. These exposures are balanced against alternative funding sources in weighing investment allocations.
 
If Congress continues to threaten funding for well-established federal programs, either through the budget process or through separate legislation, our concern over municipal credit will grow. We will update clients accordingly.
 
Howard Cure is the National Director of Municipal Bond Research at Evercore Wealth Management. He can be contacted at [email protected].