Yesterday I introduced you to Meredith Whitney’s book Fate of the States, in which she discusses the massive indebtedness of state and local governments, and their continued dependence upon more debt or federal handouts.
When the handouts cease, these dependents will starve, so to speak.
We noted that the governments in the worst shape are those with overindulgent pension obligations. But we should not make the mistake of thinking they are the only ones in bad shape. Immoral, and even corrupt debt practices abound everywhere. They will all go down eventually if they don’t stop.
To this end, you need to read the article by Steven Malanga published last June in City Journal: “The Indebted States of America.” It is long, but it is well worth the time to read. He makes many of the same points as Whitney, but goes into greater historical depth, and then pulls back the curtain: states and local governments have many devious loopholes to skirt their own laws against indebtedness, and to keep on borrowing millions and billions that will fall upon the backs of future taxpayers. Whitney makes the same point, but Malanga here gets into a little more helpful detail.
First, the historical perspective:
Most state constitutions and many local-government charters regulate public debt precisely because of past abuses. In the early nineteenth century, after New York built the Erie Canal with borrowed funds, other states rushed to make similar debt-financed investments in toll roads, bridges, and canals—projects designed to take advantage of an expanding economy. But when the nation’s economy fell into a deep recession in 1837, many of the projects failed, and tax revenues cratered as well, prompting eight states and territories to default on their debt. Stung by losses, European markets stopped lending even to solvent American states. The debacle inspired a sharp reevaluation of the role of state governments, with voters looking “more skeptically” on legislative borrowing, wrote political scientist Alasdair Roberts in 2010 in the academic journal Intereconomics. A member of New York’s 1846 constitutional convention even warned that “unless some check was placed upon this dangerous power to contract debt, representative government could not long endure.” Over a 15-year period, 19 states wrote debt limitations into their constitutions.
There. Problem solved, right. That’ll stop those states from over-borrowing.
Since then, the history of state and local debt has been a tug-of-war between those struggling to keep governments from overextending themselves and elected officials seeking legal loopholes for further debt spending. In the second half of the nineteenth century, for instance, some states, now restricted from doing it themselves, used local governments to float debt, producing tens of millions of dollars in new obligations—and calls for limits on local borrowing. The go-go 1920s, a period of unprecedented construction and transformation throughout America, saw states and localities once again borrowing massively, this time to build roads and electrical infrastructure. State and local debt had hit $15 billion ($260 billion in today’s dollars) by the Great Depression’s onset.
When the good times rolled, they borrowed and spent, and did not save. When the good times stopped rolling, they all went off the cliff:
Arkansas was one of the heaviest borrowers, with obligations reaching $160 million ($2.8 billion today). It defaulted in 1933—one of more than 4,700 Depression-era defaults by state and local government entities, including nearly 900 by school districts.
Solution? More restrictions? Yeah, why not. It worked so well last time, right?
Nope. Activist politicians found ways to create “authorities”—corporate-government entities that act outside of the technical legal parameters that govern state and local legislatures. In a way, they’re like thousands of little Federal Reserves out there—except, instead of printing money, they just borrow it from someone who does, but are just as unaccountable. Now, these entities could do the borrowing for the governments, and the legal caps and regulations mean absolutely nothing. And worse, the debt they piles up is not reported as “debt”—the governments’ balance sheets look a whole lot better than they really are. And worse yet, again, since this all takes place in legal loopholes, courts and judges—especially activist courts and judges—sanction it, and in some cases, promote it. By now, there is a tremendous body of court precedent approving of it.
Here’s one example of this corruption and its devastating long-term effects:
New York State has turned to court-sanctioned gimmickry again and again. Though New York’s constitution requires that voters approve any new government debt, only 5 percent of the state’s $63 billion in outstanding borrowing has received voter authorization, down from 10 percent a decade ago. Meantime, the cost of servicing that debt has risen by an average of 9.4 percent annually. Partly because of such unsanctioned borrowing, New Yorkers bear the nation’s second-highest per-capita load of state debt, says New York’s comptroller. The state is still paying off what it owes from the infamous 1991 Attica prison deal, in which New York, trying to close a budget deficit, “sold” the facility to one of its independent authorities, which borrowed the money to pay for it. New York also still counts on its books debt from the 1970s bailout of New York City, which, thanks to refinancing, it won’t pay off until 2033.
But local governments are just as bad, and in fact, some states depend on local governments using these same procedures so the state itself doesn’t have to. Good, freedom-loving, conservative states, like Texas:
Thanks to its low state debt, Texas enjoys a reputation for budgetary restraint. Yet as Texas comptroller Susan Combs found to her dismay, the state’s towns, cities, counties, and school districts have racked up the second-highest per-capita local debt in the nation, behind only New York’s spendthrift municipalities. The total, nearly $8,000 per resident, is more than seven times higher than Texas’s per-capita state debt. Over the last decade, local debt in the Lone Star State has more than doubled, growing at twice the rate of inflation plus population growth.
And for what? For public education and high school football:
At the moment, Texas localities owe $63 billion for education funding—155 percent more than they did a decade ago, though student enrollment and inflation during that period grew less than one-third as quickly. The borrowing has also paid for a host of expensive new athletic facilities, such as a $60 million high school football stadium, complete with video scoreboard, in the Dallas suburb of Allen.
These are not just the “Indebted States of America” as Malanga titles it. They are addicted to the debt, desperate to get more, and devious in how they obtain it.
You need to know some of the devious tricks being used to push much of the nonsense through with little to no input from voters. Aside from the mere existence of extra-legislative bond issuing authorities, check out the “certificate of obligation” loophole (stacked against voters from the beginning, and kept real quiet), and also “capital appreciation bonds” (basically a “balloon payment” delay promise that bites hard in the future):
Texas, like New York, amassed all this debt by pushing the limits of the law. Though taxpayers must approve most government borrowing, Texas provides an exception for localities that need to issue debt quickly: a “certificate of obligation,” borrowing that doesn’t require approval unless 5 percent or more of local voters petition to have a say on it (a rare occurrence, since most don’t even know that they have that power). Since 2005, Texas localities have issued nearly $13 billion worth of these certificates, often for dubious ends. In 2010, for instance, Fort Worth borrowed nearly $35 million through certificates of obligation to build a facility for horse shows.
Texas school districts have made use of another controversial financing technique: capital appreciation bonds. Used to finance construction, these bonds defer interest payments, often for decades. The extension saves the borrower from spending on repayment right now, but it burdens a future generation with significantly higher costs. Some capital appreciation bonds wind up costing a municipality ten times what it originally borrowed. From 2007 through 2011 alone, research by the Texas legislature shows, the state’s municipalities and school districts issued 700 of these bonds, raising $2.3 billion—but with a price tag of $23 billion in future interest payments. To build new schools, one fast-growing school district, Leander, has accumulated $773 million in outstanding debt through capital appreciation bonds.
Again, in many cases, the authorities borrow at will; the people can sue, but courts protect the authorities’ agenda; the people cry out, but nothing can be done:
Trenton [NJ] lawmakers announced a plan to borrow $8.6 billion through a bond offering—a shockingly high sum. Taxpayer groups reacted with such outrage that officials knew that voters would never endorse the move. So the legislature decided to channel the borrowing through an independent authority. The taxpayer groups sued, but the state supreme court brushed their objections aside, arguing that a clear precedent existed for such borrowing.
On top of all this, the process itself breeds moral hazard. States and local governments give themselves their own blank check to waste the borrowed money and spend more. The whole setup lacks accountability and subsidizes irresponsibility:
The state quickly burned through half of the borrowed money on patronage and inefficient construction practices, so it borrowed another $3.9 billion, again through the authority. Taxpayers, needless to say, will foot the bill.
Among the several recommendations Malanga gives to begin preventing this type of nonsense, the one I see as top priority is to eliminate these many authorities and their ability to provide and end-run around debt caps:
Reformers should also seek to get rid of the many loopholes that state legislators use to get around debt-limit rules. In particular, states should be banned from assuming debt through independent authorities or by direct appropriation of the legislature.
This means absolutely tying the hands of all bond-issuing authorities relevant to your area. It could be housing authorities, industrial authorities, development authorities, airport authorities, water, waste, or other utility authorities, school districts, and many more. Tying their hands would mean something like passing requirements that any spending under any authority be approved by referendum in which at least half the voting public turns out and at least two thirds vote yes. This would turn the tables in most cases from a near automatic “yes” to a near automatic “no” against which a “yes” would require widespread public support.
Any other proposed fix at this point seems powerless as long as these virtually unaccountable authorities can float debt with immunity. This is the starting point, politically. If we really value fiscal conservatism at all, we must do something about this.
Until this stops, behold, there cometh a deluge.