Meredith Whitney is a financial advisor who saw the financial crash of 2008 coming and issued multiple warnings prior. She became famous overnight. Then she became infamous in 2010 by saying state and local governments are in similar shape to the pre-crash banks, and that she expected 50 to 100 “sizeable” municipal defaults to come.
She has now written a book based upon her past few years of research on the issue. It is called Fate of the States: The New Geography of American Prosperity (2013). It is important. I will have more to say on it in the future. Here I want to address one particular startling fact she relates: the issue of ballooning public debt held by the states, and the continuing “bailout” from the federal level.
Remember that $700 billion dollar bailout of the big banks? Remember the shock that number sent throughout society? Old history right? Not really. Bailouts continue.
Aside from the general inequity of the original deal, perhaps the most common public argument against it was the creation of moral hazard: this would set a precedent for further risky behavior by other institutions that presume upon more bailouts.
Well, that’s exactly what has happened. Obama’s Stimulus Act was the second obvious bailout. States sucked up large quantities of that money, not so much to pay off their sagging debts or stimulate public works, but to maintain spending as they were, and in fact to increase it in many cases. In the most indebted states, there has been hardly any effort to cut spending—even through the most trying years after the financial crisis.
Despite all the public focus on the fiscal cliff and the need to reduce the federal debt, there has been relatively little attention paid to reducing the debt incurred by the states and backed by their taxing authority. From 2009 to 2011 that debt grew by over $400 billion, or over one fifth. And that still wasn’t enough for spending-addicted states. Rather than dealing with the root cause of this mess—too much spending on too many of the wrong things—states have papered over their budget gaps by taking more from the feds, by borrowing more from the bond market, and by shirking their responsibility to fully fund the pensions of government employees. The federal government’s outlays to states have risen more than 130 percent. They now stand at their highest levels ever and are expected to reach over $700 billion by 2016 (pp. 112–113).
So, effectively, we have another $700 billion bailout—this time of the States, whose fiscal discipline appears to be no better than the original banks.
Of course, with the Federal Reserve’s current policy of buying $85 billion of public debt every month, you effectively have a Trillion dollar bailout of government policy at all levels every year. But, hey, we all know we’re Bailout Nation at this point.
The question is, how long can this last? What will the future look like?
No one knows exactly how long it can last, but Whitney is pointing the state and local problem because it is already having real effects and drags on local societies—and also because it is leading to demographic shifts in the nation.
Long story short, the greatest drag is due to unfunded liabilities in regard to public pensions. During the bubble, home prices were high and home ownership was higher than ever. Thus, property tax revenues were up as well. Through the so-called boom years, States should have been saving to pay off huge future obligations. Instead, they kept borrowing and spending. When the bubble popped, individuals not only lost their homes in many cases, but local governments suffered as well—tax revenues plummeted. Swollen budgets then came up against massive revenue shortfall. The fat lady may sing, but she ain’t gonna get paid.
In this situation, states and local governments start cutting. Libraries get cut first. Then parks and sanitation. Then police and fire resources. Public university tuition rises. The list goes on.
With services dropping off, communities no longer seem as nice as before, or as safe. People leave. California, for example, is seeing an exodus.
But this starts what Whitney calls a “negative feedback loop from hell.” As more people leave the most affected areas, tax revenues fall that much more. More debts, more cuts, less service, less safety. More poverty. Cycle again. Next thing you know, it’s Detroit.
Whitney’s thesis, however, includes the vital acknowledgment that such is only happening in (what I would call) the liberal states: California, New England, New York, Illinois, Washington, etc. These are the places where public pensions pose the greatest (unpayable, in fact) burden on the budgets and upon future taxpayers.
In contrast, in what Whitney refers to as the “central corridor” states—Texas to North Dakota, and Indiana to Colorado, roughly—taxes are still low, debt burdens are much lower, right-to-work rules, and small business are growing. Large businesses are relocating there, saving millions in taxes. The seventeen states in this category, Whitney notes, collectively grew their economies by 8 percent between 2009 and 2011 (p. 156).
This should be explored further, but the basic thesis is correct. Municipal debt is in a position to bring down many cities. The debt is often tied directly to public pensions—often exorbitant pensions negotiated during boom years, and which have court-protected status as first priority from tax receipts. But locals, especially the smart and knowing, can simply leave those jurisdictions for greener grass in the fly-over states. Cities will indeed face tough decisions. Many will probably default in some way. Some will go bankrupt, as have San Bernardino and Stockton, CA, and Jefferson County (Birmingham), AL already.
Bailouts from Washington can not continue forever. QE-Infinity cannot go on to, well, infinity. And the changes in local communities are making defaults appear more likely all the time. It’s a looming problem and won’t go away. It will take individuals, churches, and communities willing to make sacrifices—as described in Restoring America One County at a Time—for any viable change to begin.
Whitney does speak of limited solutions. I think her ideas are baby steps, and ultimately are far too limited. But I won’t fault her for that, she is not a political scientist. Her financial sense spotted a financial problem, and on this she is correct. This much we should take seriously.