State and local governments may cut 450,000 jobs in FY2012

 Around 450,000 people who work for U.S. states, counties, cities, towns and villages could get pink slips in fiscal 2012, sharply up from the 300,000 positions shed this year, a report said on Monday.

The number of job cuts will rise mainly because the federal stimulus program is ending while the cost of Medicaid is "spiraling," said the report by UBS Investment Research.

States got billions of extra dollars primarily for education and Medicaid from the stimulus plan. Medicaid is the state-federal health plan for the poor and disabled.

Maury Harris, a UBS economist, on a conference call said the deficits states and municipalities will have to close will climb to $155 billion in fiscal 2012 from about $108 billion in the current fiscal year.

Most states and municipalities begin new fiscal years on July 1.

The deep cuts state and local governments will have to make to balance their books in the next fiscal year should clip about one percentage point from the U.S. gross domestic product -- about 30 basis points more than in the current fiscal year, the report said. "The public sector is holding back growth but it doesn't derail it altogether," Harris said.

But the $2.9 trillion municipal bond market -- so far at least -- has withstood much of the pressure from the recession-weakened finances of states and municipalities.

Thomas McLoughlin, UBS head of municipal research, told reporters that at present only about $9 billion of municipal bonds have defaulted, most of which were small, unrated issues that financed risky projects like developments.

Spooked by headlines about possible defaults, investors in municipal bond funds have sold shares for the past 27 weeks, according to Lipper data.

"I think we are seeing more traditional retail buying in the front end of the curve -- even as people investing in mutual funds were selling," McLoughlin said.

Strong demand for individual securities with short maturities is hitting during a period of exceptionally low supplies. Estimates for issuance this year have fallen to a range of $197 billion to $240 billion, McLoughlin said. That works out to about half of last year's supply of new bonds.

Still, McLoughlin's list of hazards facing the muni market include possible problems states and localities will have finding new letters of credit for variable-rate debt and what he called "rating volatility." Credit agencies are more likely to downgrade credits they have not analyzed for 18 months, for example, than ones they survey more frequently.

Muni prices, which fell last Thursday for the first time since April 12, were unchanged on Monday, leaving yields on top-rated 10-year bonds at 2.64 percent and 30-year yields at 4.31 percent on Municipal Market Data's benchmark triple-A scale.