Wednesday, November 3, 2010

Analyst: Multiple Municipal Defaults to Trigger Indiscriminate Selling

Analyst Meredith Whitney, who early on warned about the banking crisis, is out with her latest take on the debt problems at the state and local government levels.

It's not a pretty picture. In an op-ed in today's WSJ she reveals that the Federal government is already starting to bailout state governments: many other investors fail to appreciate is that state bailouts have already begun. Over 20% of California's debt issuance during 2009 and over 30% of its debt issuance in 2010 to date has been subsidized by the federal government in a program known as Build America Bonds. Under the program, the U.S. Treasury covers 35% of the interest paid by the bonds. Arguably, without this program the interest cost of bonds for some states would have reached prohibitive levels.

California is not alone: Over 30% of Illinois's debt and over 40% of Nevada's debt issued since 2009 has also been subsidized with these bonds. These states might have already reached some type of tipping point had the federal program not been in place.

Beyond debt subsidies, general federal government transfers to states now stand at the highest levels on record. Traditionally, state revenues were primarily comprised of sales, personal and corporate income taxes. Over the years, however, federal government transfers have subsidized business-as-usual state spending not covered by state tax collections. Today, more than 28% of state funding comes from federal government transfers, the highest contribution on record.

These transfers have made states dependent on federal assistance. New York, for example, spent in excess of 250% of its tax receipts over the last decade. The largest 15 states by GDP spent on average over 220% of their tax receipts. Clearly, states have been spending at unsustainable levels without facing immediate consequences due to federal transfer payments and other temporary factors.
And, as part of this round-robin madness, states then bailout local governments. Here's Whitney again:

At the same time, local governments now rely on state government transfers for 33% of their funding. Thus, when a state finds itself in a financial bind, it has the option of saving itself before saving one of its local municipalities. Pennsylvania recently assisted the state capital, Harrisburg, in the form of a one-time "advance" payment—but there are hundreds of towns like Harrisburg that will also need assistance. These one-time fixes fail to address the real structural problems facing so many states and municipalities.

State budgets are likely to experience their second consecutive year with deficits of close to $200 billion. The root of the problem is simple: State governments have spent recklessly and unsustainably. Rainy-day funds are depleted, pension-fund contributions are already at record lows, and almost all of the major federal government subsidy programs will run out in June 2011.
Whitney then points out that the enormity of the situation means that the bailouts to-date will come nowhere near solving the problem:

Until now, the states have been able to evade the need to rein in spending largely because the federal government enabled them to do so through record high federal allocations, and by creative accounting that put off funding well over a trillion dollars of state-employee pension and other retirement obligations.

The level of complacency around this issue is alarming. Most assume...that the federal government will simply come to the rescue of the states without appreciating the immensity of the cumulative state-budget gaps
How does she expect it all to end?
I expect multiple municipal defaults to trigger indiscriminate selling, which will prompt a federal response.

As I pointed out recently in my post, Bernanke Tells the Truth: The United States is on the Brink of Financial Disaster, Bernanke in a speech clearly laid out the dangers of the debt problem at the Federal, states and local levels. Curiously, this very important speech was given little coverage in MSM, but Bernanke laid out the problem in much the same fashion that Whitney has. Although, Bernanke failed to mention the somewhat secretive bailouts that are already going on.
I suspect this huge debt overhang may be the true reason for QE2, and then QE3, QE4 etc. Bernanke may want to print enough new money to significantly devalue the worth of the dollar so that the Federal government along with state and local governments will be able to pay off their debts in the newly printed cheap dollars that will be floating around everywhere.

1 comment:

  1. Hey ... I have an idea. How about means testing all those government retirees collecting those high 5 and six figure pensions?