Wednesday, December 29, 2010

State Budget Crises: A Storm On The Horizon

Back in August, the Independent Report featured a story about the tattered balance sheets of the states. Even then, it was quite obvious that trouble was brewing.

However, the dire condition of state budgets across the nation is something the mainstream media has largely ignored — until now. The problem has reached such catastrophic proportions that it can no longer be disregarded.

In fact, 60 Minutes recently featured a story highlighting the unfolding crisis.

Meredith Whitney, one of the most respected financial analysts on Wall Street, warned 60 Minutes about the next financial meltdown — in state and local governments.

Whitney, who made her reputation by warning that the big banks were in big trouble long before the 2008 collapse, was blunt.

"It has tentacles as wide as anything I've seen. I think, next to housing, this is the single most important issue in the United States, and certainly the largest threat to the U.S. economy," she told 60 Minutes.

New Jersey Governor Chris Christie concurs.

"It's not like you can avoid it forever, 'cause it's here now," said Christie. "And we all know it's here. And the federal government doesn't have the money to paper over it anymore, either, for the states. The day of reckoning has arrived. That's it. And it's gonna arrive everywhere. Timing will vary a little bit, depending upon which state you're in, but it's comin'."

Nationwide, state and local governments are now sitting on a mountain of debt that has reached an all-time high of 22 percent of U.S. GDP.

Historically, municipal bonds have been viewed as the safest of investments. However, many analysts are now openly talking about the possibility of a municipal bond market crash in 2011.

If such an event does occur, things such as roads, sewer systems, water systems, etc., would no longer be repaired, much less constructed. State and local governments would have to raise taxes significantly. Even then, it's likely that many would still be unable to meet their funding needs.

New Jersey faces a $10 billion deficit.

California faces a $19 billion budget deficit next year and its credit rating approaches junk status. It now spends more money on public employee pensions than it does on the state university system.

And Illinois spends twice much as it collects in taxes and is unable to pay its bills. The state currently owes about $5 billion and has no credible solution to its problems. State Comptroller Dan Hynes calls Illinois "a deadbeat state".

Nationwide, the generous retirement and health care packages given to public employee unions are now grossly underfunded. Two prominent university professors have calculated that the combined unfunded pension liability for all 50 U.S. states is approximately 3.2 trillion dollars.

According to Whitney, no one really knows how deep the holes are. She and her staff spent two years and thousands of man hours trying to analyze the financial condition of the 15 largest states. She wanted to find out if they would be able to pay back the money they've borrowed and what kind of risk they pose to the $3 trillion municipal bond market, where state and local governments go to finance their schools, highways, and other projects.

"The lack of transparency with the state disclosure is the worst I have ever seen," Whitney says. "Ultimately we have to use what's publicly available data and a lot of it is as old as June 2008. So that's before the financial collapse in the fall of 2008."

The deficit problems of the states have become the problems of local governments, which depend on their state for a third of their revenues. Whitney is convinced that some cities and counties will be unable to meet their obligations to municipal bond holders who financed their debt.

"There's not a doubt in my mind that you will see a spate of municipal bond defaults," Whitney predicted. "You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars' worth of defaults."

That's a frightening prospect. Since huge numbers of municipal bonds are held by big banks, even a few defaults could affect the entire financial market.

According to Whitney, there's a gathering storm on the horizon.

"It'll be something to worry about within the next 12 months," she warns.

This spring, the $160 billion in federal stimulus money that has helped states and local governments limp through the great recession will run out. The states will need additional help and will almost certainly ask for another bailout.

However, right now, bailouts are political dynamite in Washington. That's because the federal government is also broke and facing a national debt that has now reached $14 trillion.

These problems have been mounting for many years and now the moment of reckoning has finally arrived.

We're in for some rather ugly political battles, and even worse outcomes. A total economic collapse is quite likely, if not inevitable.

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