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Jul. 2011, Baltimore Sun: United States Default

What happens to Maryland if the U.S. defaults?
State's AAA bond rating would be put at risk if Congress fails to raise debt limit

By Jim Rosapepe
July 21, 2011

Earlier this week, Moody's credit rating agency announced it is reviewing the credit of Maryland and four other AAA rated states in light of the debate in Washington about the possible default of U.S. government debt — even though Maryland pays its bills on time.

It may seem myopic to focus on what U.S. government default would mean for Maryland, but our state's members of Congress should think about it as they consider the willingness of some Republicans in Congress to default rather than vote to raise the nation's debt limit.

Maryland's own debt has had a AAA bond rating for 50 years. Obviously, it has saved taxpayers' money by allowing us to pay lower interest rates on state borrowing. More importantly, it has been a lodestar for fiscal responsibility and a metaphor for the good fiscal management Maryland has had for decades.

Maryland is one of the most fiscally responsible states in the union. Members of Congress from Maryland like Sen. Ben Cardin and Reps. Steny Hoyer, Chris Van Hollen, Elijah Cummings and Andy Harris know from first-hand experience in our legislature how we've done it. When we need to cut spending or raise revenue, we do it.

It's always politically tough to cut spending or raise revenue. All of us want great schools, good roads and transit, safe neighborhoods, a clean environment — and low taxes. But there is no free lunch — despite tea party theories to the contrary.

That's why the debt limit debate in Washington is important to our country, our world — and our state.

Our AAA bond rating is based on the credit rating agencies' belief that the risk of Maryland defaulting on our state debt is not much greater than the risk that the US 

government will not pay back its bondholders.

But international bond buyers — from Shanghai to Zurich — don't know Annapolis, Maryland from Ankara, Turkey. If America defaults, they'll wonder, will U.S. states be far behind? I know from my work in international investing that "country risk" (if the U.S. defaults, U.S. states, cities, and companies may too) is a major determinant of subnational and corporate risk.

A totally rational market — what the right wing believes every market to be, despite evidence from the Dutch tulip bubble of the 17th Century to the Great Recession of the last few years — would reward Maryland for its fiscal responsibility by selling U.S. Treasuries and buying Maryland bonds, protecting our AAA rating.

But, as the great economist and investor John Maynard Keyes explained, financial markets aren't driven only by rationality, but by "animal spirits." A less diplomatic term would be irrationality.

I saw this in 1998 when I was U.S. Ambassador to Romania. That summer, Russia defaulted on its government debt, just as many tea party Republicans are urging the U.S. to do today. Romania had paid its debts for years and was committed to keeping its record intact, but suddenly, traders were selling its bonds at 50 cents on the dollar, as if they had suddenly become junk. Why? We joked that bond buyers in London, Zurich, and New York couldn't tell the difference between two eastern European countries whose names begin with the letter R. But the truth was that Keynes was right. Financial market prices are a mix of economic fundamentals — and "animal spirits." (Incidentally, Romania didn't default on its debt.)

A U.S. default shouldn't raise Maryland bond interest rates — but it will. And it may well cost us our AAA bond rating — even if we pay our bills.

They call it credit for a reason — in Latin, it means trust. Lenders can trust that borrowers will repay their debts. Lenders to Maryland have been able for decades to trust we'll pay them back.

Shouldn't lenders to our federal government have that confidence too?

Sen. Jim Rosapepe, a Democrat representing College Park, was vice chairman of the Maryland House Ways and Means Committee (1995-7) and U.S. Ambassador to Romania (1998-2001). He now heads an investment firm active in the U.S., Europe and emerging markets. His email is jim.rosapepe@senate.state.md.us.