Is Connecticut’s debt changing outlook for bonds on Wall Street?

When measured against its sluggish economy, Connecticut’s huge bonded and pension debt ranks worst among all states, a leading Wall Street publication asserted this week.

But while Barron’s, a financial weekly published by Dow Jones & Co., wrote that growing debt in most states is changing how some investors look at the municipal bonds, it also concluded that Connecticut’s fiscal problems aren’t heavily reflected in the market.

Municipal bonds are popular in many investors’ portfolios because they often are exempt from federal and state income taxes. But because municipal finances are so dependent on state budget decisions, market analysts look closely at the fiscal health of states when deciding which municipal bonds to recommend for investment.

“It shows a legitimate cause for concern,” economist Don Klepper-Smith of Datacore Partners in New Haven said of the article, “State of the States.” “It shows there’s considerably more risk (in municipal bonds) than is currently believed, certainly more than many people are aware of.”

Reports of Connecticut’s hefty debt are nothing new.

The Nutmeg State ranked among the four worst states in 2010 at saving for public-sector retirement benefits, the Pew Center on States reported last June.

And Connecticut has long had a significant capital debt.

It entered 2012 with nearly $19.5 billion in debt tied to various capital projects, according to Gov. Dannel P. Malloy’s budget office. That’s $5,569 for every man, woman and child in Connecticut, based on U.S. Census numbers.

But state officials have responded over the years by pointing to Connecticut’s considerable wealth relative to other states.

Yet the Barron’s article, which measured both bonded and pension debt and then compared them with gross state product — or the annual value of the businesses’ economic output — ranked Connecticut dead last.

Connecticut, which had debt equal to 17.1 percent of its economic output, was one of just 11 states in double-digits.

South Dakota ranked first, with debt equal to 1 percent of its gross state product.

New York, which ranked in the middle of the pack at 28, has debt equal to 5.7 percent of its output.

Connecticut’s other neighbors all ranked in the bottom 10, including: New Jersey, 42nd, 12.2 percent; Massachusetts, 43rd, 12.8 percent; and Rhode Island, 44th, 13 percent.

James Finley, executive director of the Connecticut Conference of Municipalities, said his members have not seen any signs that their bonds are any less popular among investors.

Besides its taxing authority, and the huge pocket of wealth centered in Fairfield County, Connecticut also differs from other states in that it has a multi-tiered system for quickly intervening when any municipality gets into fiscal trouble, Finley said.

“It would be almost impossible for a Connecticut municipality to default or go bankrupt given the system of intervention we have,” he said.

Over the last two decades, the state has appointed receivers to temporarily take control of finances in West Haven, Waterbury and in Griswold’s borough of Jewett City in southeastern Connecticut.

Connecticut does differ from many other states in that it has no county government and supports many long-term liabilities, including teacher pensions, at the state level.

Also unlike some other states, Connecticut pays for a significant portion of municipal school construction costs at the state level.

“Granted, the risk of Connecticut — or any state, for that matter — defaulting on its debt is small,” journalist Andrew Bary wrote for Barron’s. “But investors are not being rewarded for taking any risk at all.”

And Klepper-Smith said major companies are beginning — and can be expected to continue — to weigh the poor fiscal discipline in many states when deciding where to invest.

“We all have to live within our means at some point,” he said. “Our obligations are real and need to be accounted for, and those disparities (between debt and economic output) are an underlying source of tension.”

Connecticut didn’t save long term for its state employees’ pensions until unions took the state to court to force creation of a pension fund in the early 1980s.

According to the latest valuation, the fund was worth $10.1 billion on June 30, 2011, with $21.1 billion in obligations, for a funded ratio of 47.9 percent.

State Treasurer Denise L. Nappier’s office, which oversees pension investments, declined to comment on the Barron’s article.

The savings picture for retiree health care is worse than that for pensions.

Connecticut has $17.9 billion in long-term obligations to provide retiree health coverage. Connecticut didn’t start saving anything until 2007 and had only $50 million set aside — less than one-third of 1 percent of the total obligations — in August 2011, when unions ratified a concessions deal negotiated with Malloy.

That deal requires all state employees to contribute 3 percent of their annual pay to the retiree health care savings account, and requires the state to match those contributions starting in 2017.

“The issues outlined in this report were decades in the making,” Brian Durand, spokesman for the state Office of Policy and Management, said Monday. “Since inheriting the problem, Governor Malloy has taken a number of steps to shore up the state’s finances.”

Besides requiring increased contributions toward retiree health care, the August 2011 concessions deal also  raised regular retirement ages for several employee classes, increased penalties for early retirement, modified cost-of-living adjustments to pensions and offered a new hybrid retirement program.

And earlier this year, Malloy secured both legislative and union approval to make an extra $3 billion in pension contributions in total between this fiscal year and 2023. After 2024, the contribution would drop annually. Between now and 2033, Connecticut would save an estimated $5.8 billion, with most of the savings coming in the final five years of that period.

Malloy also inherited a built-in deficit projected as high as $3.67 billion — or nearly one-fifth of all spending — in the 2011-12 fiscal year, a gap he closed with a combination of tax hikes, labor concessions and other spending cuts.

“The result is that we’ve finally put our finances on the road to long-term sustainability,” Durand said.

But state Senate Minority Leader John P. McKinney, R-Fairfield, said the governor and his fellow Democrats in the legislature’s majority relied too heavily on taxes to tackle last year’s deficit. More than $1.6 billion in state and local taxes were approved in 2011-12.

“There were some changes, but they did not seize the opportunity to make real and significant long-term change,” McKinney said. He noted that one of the three major Wall Street credit rating agencies, Moody’s Investors Service, downgraded Connecticut’s bond rating back in January, citing a heavily loaded state credit card, huge debts in pension and retiree health care programs, and a depleted emergency reserve.

“That was the loudest warning sign that we need to change direction and get a better handle on our long-term debt,” he said.