Debt Downgrade – Is North Carolina Next?

The recent Standard & Poor’s downgrade of federal debt instruments sent waves of fear across indebted government agencies across the nation. Just days after the federal downgrade, S&P issued downgrades for thousands of municipal and other local bonds, including a series of bonds held by the Board of Governors of the University of North Carolina. Fortunately, the state of North Carolina’s prized AAA bond rating has not been downgraded – yet.

According to the 2011 Debt Affordability Study produced by the North Carolina Department of State Treasurer, North Carolina appears to be on a collision course with a debt downgrade of its own.

The culprit? A decade-long commitment by state lawmakers to intentionally deny North Carolina taxpayers any voice over the issuance of new state debt.

Article V, section 3 (1) of the North Carolina state constitution explicitly states the General Assembly must first seek voter approval for “debts secured by a pledge of the faith and credit of the State.” This traditional method of public finance typically results in “general obligation” (GO) bonds.

Not content to first gain voter approval for their spending sprees, however, state legislators exploited the phrase “secured by a pledge of the faith and credit of the State” to develop “special indebtedness” instruments, most notably a funding mechanism known as Certificates of Participation (COPs).  COPs are debt instruments “secured” by the value of the asset being financed – typically a new building. Thus, COPs technically are not required to receive voter approval.

Unsurprisingly, the ability to circumvent voter approval and skirt any accountability for debt spending drew many elected officials to this new instrument. The State has relied exclusively on “special indebtedness” since 2000, meaning that a growing share of total outstanding state debt consists of non-voter approved debt.

Since abandoning the bond referenda process in 2000 in favor of COPs, state debt has predictably exploded. Per capita state debt has more than doubled. Annual debt service payments on the debt have tripled. Moreover, the state has authorized, but not yet issued, another $1.6 billion in debt (as of June 30, 2010).

What has been the impact of the spending binge? In short, North Carolina’s General Assembly maxed out the state’s credit card. Both the 2010 and 2011 Debt Affordability studies concluded that the state has “substantially exhausted” its capacity to issue new debt without threatening its debt rating.

And the legislative leadership from 2000 to 2010 ran up this tab without even asking permission of those who will pay the bill – us.

Furthermore, the Debt Affordability studies suggest that the exclusive use of “special indebtedness” over the last decade could very well lead to a debt downgrade for North Carolina. They conclude that “including all authorized but unissued debt, the percentage of non-GO debt is projected to increase well beyond the medians for ‘triple A’ states and exceed the median for ‘double A’ states as well.”

In other words, because of the exclusive reliance on special indebtedness over the last decade, North Carolina could be facing a debt downgrade in the near future.

Recent polling shows that an overwhelming 77 percent of voters believe that the North Carolina General Assembly should not be allowed to borrow money without voter approval. In spite of such massive public opposition, state lawmakers have issued billions in new debt over the last decade without one penny of it being approved by voters.

For years, fiscal conservatives in the state have been warning that the reckless, unchecked debt spending binge embarked upon by elected officials in Raleigh would have negative repercussions. But they didn’t listen.

New leadership in the General Assembly this year, however, at least offered a glimmer of hope for a more fiscally prudent legislature going forward.  Legislation (HB 491) to repeal the statutory authority for Certificates of Participation was introduced this past session. The bill passed the House, and has been referred to the Senate Finance Committee where it can be picked up for debate next year.  

In addition, SB 464, The Debt Reduction Act of 2011, cancelled $232 million of yet-to-be-issued debt approved during the previous three sessions. That’s not an insignificant step, and definitely one in the right direction.

There has been much finger-pointing in Washington lately, with politicians playing the blame-game over the federal debt downgrade. If North Carolina faces a similar downgrade in the near future, there will be little doubt where the blame lies.

EDITOR’S NOTE: The original version of this article mistakently identified HB 491 as being replaced by an unrelated committee substitute. Civitas regrets the error.