A Subsidy to the States: Determining the Value of the Implied Federal Guarantee on US State Debt by

The global financial crisis of 2008 and 2009 has called into question the fiscal sustainability and solvency of several US state governments. As more of these states approach insolvency, discussion of a federal bailout has increased. As a result, we develop and use a model that accurately forecasts sovereign credit ratings and apply it to the fifty states to determine a stand alone credit rating and spread. Using this stand alone spread, we are able to calculate the approximate subsidy being given to each US state by the federal government (in the form of cheaper credit) and apply the subsidy to US debt to get a sense of the true costs of these subsidies. 1 I am eternally grateful to Professor Sundaram. Without his patience, advice, and insight, I would not have been able to complete this paper. His ability to take my rambling and, at times, disjointed thoughts and focus them on a specific issue gave me the ability to finish this work. Further, I owe thanks to the entire Stern School of Business and, in particular, Professor Subrahmanyam for his continued support for the honors program. I would like to congratulate and thank the entire Stern Honors Class of 2011, without whose assistance, encouragement, and lightheartedness I would not have been able to complete this project. Finally, I am indebted to my family (Mom, Dad, Haley, and Abby) for their love and support throughout the last four years.