Watch the State of the States

I have long said that the health of the states is a more valid measure of the health of the nation than looking at national statistics.  Why?

  • The states can’t print money, or force ask allow the central bank to buy their debt.
  • In general, the states must run balanced budgets.  (Would that we constrained the Federal government to do the same through amending the Constitution.  Somebody bring that up after the crisis is over, please?)
  • State statistics are more reliable than Federal statistics, because they serve fewer political goals.

So, what is going on with the states?  I invite readers to comment below on the affairs of their states; I am only going to cover a few big states tonight.  I will start with Illinois.

Illinois has gotten to the point where it is no longer paying its bills.  After years of deferring paying into their pension plans, and borrowing to cover shortfalls, there is no flexibility remaining in the Illinois budget.  The games that can be played accrual items have been played out, and the deficits in pension and retiree health plans are huge.

Rather than the legislature or the governor choosing what taxes to raise and what benefits to cut, well-meaning bureaucrats decide who will get paid and who won’t.  It is a haphazard way of setting priorities.

What will it take for Illinois to act? This isn’t so much an economic problem as a cultural problem.  Can the people of Illinois elect and direct their civil servants to do what is reasonable within taxation levels agreed to by the majority?  This crisis will test what it means to be the state of Illinois.

Then consider New York.  Governor David Patterson is vetoing 6,900 bills because the budget is out of balance.  What will the legislature do?  I can’t tell, but Patterson is showing some lame duck spine.  New York can’t manage with such large deficits.

California is notable, given Governor Schwarzenegger’s move to cut all government salaries to the minimum wage.  But can it be done?  Can the computers be reprogrammed to do it?  And is this the right way to balance California’s budget, or is it just a ploy to get the legislature to compromise?  The courts are going along with the move for now.

New Jersey has bitten the bullet in the short run, and has balanced its budget through shared sacrifice.  Here’s to the man who found courage when faced with the crisis, Chris Christie.  He did one of the hardest things in politics — get warring parties to compromise over budget priorities.  That is tough, as opposed to making decisions where the options are limited during a crisis, like 9/11.  There is little true heroism involved at such times, because the few courses of action are obvious.  That said, it makes the Bush Administration’s dealing with Katrina all the worse, because the options were also few.  (Yes, blame the Louisiana Governor as well, but really, what does it take to get real focus in a crisis?)  In a crisis, someone has to be ugly to get response.

All that said, the crisis in the states is likely to get worse over time, and the main reason is that the states have underfunded their employee benefit plans, and offered benefit increases which cost little in the short run, rather than fight unions over wages.  Perhaps the unions were too clever.  They are pushing the states toward a non-existent bankruptcy.  What if a state stops paying pensions and retiree healthcare?  What then?  The federal government orders them to do so.  But what if they ignore that?  The Feds have no right to order a state to do anything, outside of what the Constitution allows.

In a stylized way, this is what happened.  When states created pension plans, there was a path of expected benefit payments associated with them.  The path of funding the payments was more level than the rising curve of the payments, but states paid in less than the funding path, partly because the markets had done so well.  That led them to assume that the markets would continue to do so well, so their path of funding was reduced in the present, but higher in the future.  It also led them to bias negotiations in favor of offering higher future benefits, and less in current wages.

This worked well so long as the markets were doing really well, up through 2000.  But once that ceased to be true, the path of expected benefit payments was much higher then before, and steeper going into the future.

That is why it will be difficult for the states to get ahead of their funding path shortfalls.  In an era of low interest rates and low market returns, taxes must be raised to now pay real money into the plans, and an increasing amount each year.  It is not as if they are to the point where they have no assets in the plans and must make benefit payments out of cash flow, but the plans are distinctly underfunded on any basis that assumes fair investment returns over the next 30 years, which would be 5% per year, and not 7-9% per year.

So even for states that are presently virtuous like New Jersey, it will be hard to get out of their crises.  It will be even worse for states that are bargaining with the future and betting on a quick return to the false prosperity that was the product of an increasingly leveraged society, 1984-2007.

So watch the states.  The true picture of the nation is there; they don’t have a lot of wiggle room, and will have a difficult next two decades as the demographics catch up with the underfunding of employee benefit plans.


  • lfhill says:

    Hi David

    As usual a great article. Thank You.

    I have thought in the past about balancing the federal budget. However, I came to the conclusion that this may not be a good idea.

    In the case of war, there may be a need to borrow much more than a balanced budget may allow. The priority, in this case would be sovereignty rather than debt. It is in our history.

    Even in times without war but in economic troubles, sovereignty may be an issue. Look at the Greek Islands of today and England’s loss of the Suez Canal in 1952.

    When you get down to it; there are only two real checks on the profligate politician. One is a backed currency; which we have done away with. And the second are multiple currencies which Europe has done away with.

    It will be interesting to see what happens to the Euro.

    I am not an advocate to jumping back to the gold standard; there would be many problems with that. With only $ 5 trillion in physical gold; I can’t imagine how that could settle accounts for a $ 50 trillion global GDP. It would call for gold to be in excess of $ 10,000 per ounce. That would cause great economic dislocations to have that change.

    Gold has issues outside of that; there are many more times of gold trading than there is gold in existance. I am not sure exactly why that is not a ponzi scheme but I stay away from that. I know I am not smart enough to be on the right side of a trade with J.P. Morgan.

    Thanks, Louie

  • RedSt8r says:

    My state, NC, is a microcosm of CA and NY. Public employee pensions and state/local budgets all out of whack. The politicians have taken two routes: a) hope for federal money to bail them out; and b) pretend this is only a temporary problem and nirvana will shortly return.

    Couple of anecdotes from our local paper.

    Clerk of Court recently retired at 48. Asked what she will do now her response was that she had to do something because she won’t qualify for her pension until age 50! FIFTY?

    Nearby city with new administration is frustrated because half (yeah, 50%) of their property tax revenue will be spent to pay for the public buildings erected in the past couple of years. Half the revenue! One council member noted that maybe they overbuilt a little bit.

    Recent front page article noted that the cost of homeownership has risen some $900 annually over the past few years due to rising taxes and fees. This year my county raised property taxes and raised the sales tax. Both were necessary to pay for the increased cost of bonds sold in the past few years. How the cost of the bonds has increased years after being sold is not explained. I wonder if some Wall Streeter’s talked them into debt swaps.

  • Geekzer says:

    There is another serious cause of state budget problems: The requirements that states absorb some of the costs of federal programs.

    We’ve seen that most recently in the Health Care Reform bill, where states are somehow expected to manage increases in Medicaid patients. Federal support for these additional costs may arrive but is not guaranteed.

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