Thursday, September 2, 2010

The lights are starting to go out (a rare post topic)

The Lights Are Starting To Go Out

48 states are projected to have budget deficits this year. Countless municipalities (with more limited taxing power) are in worse shape and we’ve already seen the first bankruptcies in cities such as Vallejo, California. Harrisberg, PA passed a budget that didn’t include debt payments (effectively a default). Central Falls, RI has turned its finances over to a receiver. In all, about $2.8 trillion in municipal debt is outstanding ($1 trillion directly held by households; the effective number is much higher). Municipal debt is that which is issued by cities or other local governments and their agencies.
Ben Bernanke recently stated that the Fed will aim to keep interest rates low for the near term, citing the “sluggishness of the national recovery” and the resulting budget woes at the state and local government (a “significant” or “severe” threat to the economic recovery, as per an AP Economic Survey). High and lingering unemployment, decreased consumer spending and corporations remaining conservative due to economic uncertainty are keeping tax revenues low.
Experts have estimated that the states face $350 billion in deficits over 2010 and 2011. While President Obama has pledged $140 billion in aid over a 2.5 year period that sum doesn’t come close to narrowing the projected gaps. If interest rates don’t stay low, some of that debt will most likely need to be rolled over at higher rates of interest – pushing up the projected deficit numbers. At the federal level, the average maturity of US government debt is currently about three years; meaning that rising interest rates will greatly increase the federal government’s own obligations, making it harder for them to bail out state and local governments.
The municipal market is also quite illiquid – so the ability to find bid/ask prices will freeze should there be a rash of defaults. Much as we learned during the recent financial crisis an illiquid market can close almost completely, leading institutions to liquidate higher quality assets to meet obligations (such as margin requirements, loan covenants, reserve requirements or redemptions).
Add to the municipal debt burden unstated debts – such as shortfalls in state and local pension funds – and the municipal burden only increases. Joshua Pauh (Northwestern University) and Robert Novy-Marx (University of Chicago) recently recalculated the 50 states pension plans by valuing the obligations as the bond market values debt. They arrived at a $5.17 trillion number. As only$1.94 trillion has been set aside in state pension funds the resulting deficit is $3.23 trillion.
In the news media we read about the battle for teachers’ jobs, the post office stopping Saturday delivery and four day weeks at schools and governmental agencies. What are we actually seeing?
Hawaii has gone to a four day school week. Illinois announced earlier in the year that it was $9 billion behind in payments to its vendors. Clayton County, GA has cut bus lines. Colorado Springs, CO cut a third of its streetlights this past winter. Schools across New Jersey are cutting language classes and using online programs instead. The Pentagon has announced that it’s cutting thousands of jobs. Each day we read about one more cut or threatened program. Can we really fund such large projected deficits by closing parks or limiting library hours?
This country needs its elected officials to organize a comprehensive approach instead of trying to nickel and dime their way out of a crisis. The cuts need to be felt across the board – including among the unionized and government workers – regardless of fears related to how these vested special interest groups retaliate in future elections.
Otherwise, which career politician will volunteer to turn the last light off?

No comments: