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By Miriam Sjoblom, CFA | 06-10-2011 12:21 PM

State of the State for Muni Investors

AllianceBernstein's Michael Brooks on state budget gaps, growth concerns, the possibility of default, and the pension problem.

Miriam Sjoblom: Hi. I'm Miriam Sjoblom, associate director of fund analysis at Morningstar, and I'm here at the Morningstar Investment Conference with the municipal bond manager at AllianceBernstein, Michael Brooks. Thanks for joining us, Michael.

Michael Brooks: My pleasure.

Sjoblom: Well, there has been a lot of concerns over the past year in the headlines about credit risk in the municipal bond market. Can you talk to us a little bit about how states and local governments are doing at balancing their budget in this very difficult economic environment that they have been in?

Brooks: Well, states, in particular, let's focus on states at first. States have had a difficult time. Tax revenues of states took a gigantic drop. They reached a peak in September of 2008, which by the way was the month that Lehman Brothers filed for bankruptcy, and from that point through the next five quarters they dropped by $97 billion. That was the biggest drop that we have ever seen. That resulted in gigantic budget gaps across the nation, and if you were to add up in fiscal year 2010 all of the state budget gaps, you're going to come to a number of about $191 billion. That's on a base of about $725 billion. That's an average budget gap of a state of 26%. That's enormous. Some of those states were 40%, others were much smaller, but an average of 26%--that's an unprecedented number.

The federal government came in and picked up about a third of those budget gaps, but that money is going to disappear in fiscal year 2012. They are only getting $6 billion. So the question then becomes, if the budget gaps did not decline, then the state share is going to increase dramatically, but the budget gaps actually have declined dramatically, largely because tax revenues have improved. State tax revenues are now not back to where they were, but they're halfway back to where they were from that big gigantic drop. And states are taking actions to fix the problems. I mean, it's painful, they have to lay off people, they're putting people on furloughs, they're cutting aid to localities, they're raising taxes, they're doing a variety of things. But the size of the budget gaps have shrunk, and therefore, the amount that the states are going to have to deal with in fiscal year 2012 is actually a tiny bit smaller than it was in 2011, and that's a good trend, and that will continue, I believe, going forward.

Sjoblom: We've seen lately some signs of slower growth, some kind of discouraging signs about the economy. So, even though you're seeing improvements, are we still in a really challenging period?

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