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Doomsayers Predicting State-Municipal Defaults

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If you have a taste for gloom and disasters, then you will enjoy predictions of the coming default by states and municipalities across America on their heretofore sacred municipal bonds, the munis so beloved of retirees and pension funds. These bonds are the way local and state governments financed building the Interstate Highway system, schools, sewer plants, power grids, civic centers, every kind of infrastructure that underpins the modern way of life. Because these income investments were considered safe and were tax-free, they fill millions of retirement funds around the world, but now the sponsoring governments are on the brink of bankruptcy, almost at the point where they have run out of various fancy Enron-style bookkeeping tricks to conceal that fact, and observers say the next option is to default on paying the interest.  Says Frederick Sheehan, a muni bond analyst:

“This gradual deterioration of municipal finances has quickened over the past several months. Spending is rising and revenue is collapsing. Funding gaps have been disguised by accounting gimmicks.”

Says Arthur Levitt, Former Chairman of the SEC:

“Fraud in the municipal market and incompetence, which in some ways is worse than fraud, has never been greater.”

We all recall how Governor Schwarzenegger of California recently paid state bills with I.O.Us, drawing on future tax receipts. Some other examples, according to various investment newsletters:

*Arizona plans to sell and lease-back its State House and Senate buildings, in an attempt to raise a one-time cash influx not unlike Virginia Governor McDonnell’s plan to sell off state-owned liquor stores

*Colorado Springs has let one-third of its street lights go dark, sold police helicopters on e-Bay, and stopped all street paving

*States from Kansas to Hawaii have considered bills to cut the 5-day school week to four, or to cancel entire grade-years altogether

*Los Angeles wants every city agency except Fire and Police to cut back to a 3-day week

*Harrisburg, Pennsylvania (state capital) has already skipped its 2010 debt payments, and its debt is now considered “high risk junk” by Moody’s (the same rating agency which continued to rate AIG and derivatives AAA right up to the crash on Wall Street, so make of this what you will).

The consensus is that as many as 48 American states are very close to bankruptcy… a train wreck in slow motion which may have been a long time coming but is, especially according to conservatives and committed Free Market analysts, inevitable. The obvious trigger is that expenses have continued to rise but revenues have collapsed—- no surprise when total real unemployment is around 18+ percent (including those who have been discouraged and quit looking, and those who have been reduced to part-time low-wage jobs), real estate values have plummeted (with commercial real estate just beginning its own serious downturn), sales tax receipts are down, and the stock market, despite wild volatility, has pretty much flat-lined (when it hasn’t continued its bear market downtrend) so that state and local pension funds now have a deficit estimated to be well over $3.2 trillion.

What will happen next? The Big Money and Wall Street are quietly unloading their store of municipal bonds, but innocent small investors are unwarned and, as always, they are the ones who will suffer when the defaults begin.  This has actually happened before, mostly during the last downleg of the Great Depression, when many, many defaults on munis occurred. The answer then was to raise taxes at both state and national level, but times are different today. If states tried to raise taxes as they did in the ’30’s, it would almost certainly abort our fragile recovery and throw us into a greater recession. Moreover, it is hard to imagine today’s politicians ruthlessly cutting out  entitlements (look at the riots in Greece over just such cuts)—- most electeds will not have the political will. Therefore, it is quite possible even many Republicans would join Democrats in Congress to authorize a bailout, and such a bailout would dwarf every previous bailout…. i.e., the Fed would print fiat money out of thin air at a pace that would make Alan Greenspan’s bubbles look anemic.

As you know, most Free Market economic theorists deeply believe we, as a nation and as a global economy, are careening toward runaway inflation; and they believe such an enormous bailout will inevitably produce hyper-inflation on the order of Germany in the 1920’s, unraveling our society in the process.

This belief is at the foundation of the conservative-Tea Party hysteria over reducing the deficit. Indeed, I believe the Republicans, based on this scenario, are doing everything they can to make a double-dip recession and hyper-inflation into a self-fulfilling prophecy by doing such things as refusing to extend unemployment benefits or add to the deficit in any way.  It seems as if the Republicans want the economy to stall out so they win in November and, if states begin defaulting next year, also win in 2012—- sounds like their business plan for America. It is their contention that reckless spending on lavish entitlements got the states in trouble, rather than the reckless greed of Wall Street and its meltdown.

Some economists have said that, Yes, we need to bring our deficit under control (and are careful to distinguish between the budget deficit and the national debt, something the instant experts of the Tea Party do not do); but they also caution against immediately trying to stop all deficit spending, or cutting entitlements, or raising taxes on the middle class because that in itself will surely kill the recovery. This is exactly what happened in 1937 when FDR listened to conservatives, stopped his deficit-financing of New Deal programs, and thus brought about a second downward spiral in the Great Depression, a depression finally ameliorated by the massive deficit spending of World War II.

The Republicans and Wall Street have gone out of their way to demonize everything Keynesian, and deficit spending is Keynesianism personified. The only problem is, deficit spending works when it comes to stopping a self-feeding depression. It works no matter how much the Free Marketeers of Friedman economics keep saying it does not. We would be further out of our current recession if the Free Marketeers in Congress had not prevented passage of a bigger stimulus package, and not then hamstrung any other real stimulus programs Obama wanted, mostly with self-righteous remarks about curbing “the deficit.” Even some conservative economists are now warning against smothering the recovery with foolish constraints on deficit spending at this moment. They agree, we should create a plan to reduce the deficit, but should not implement it until the recovery is more firmly underway…. even if it means temporarily adding a little more to the deficit.

Where does this leave us with the predicted defaults by soon-to-be-bankrupt states? Well,

*First, the situation is not uniformly dire—- it has been said that the perpetually gloomy soothsayers have foretold five of the last two recessions (that is, they may exaggerate a little bit—- in order to sell their newsletters and investment advice, perhaps?).

*Second, the feds bailed out the bondholders in the Wall Street meltdown, so why not an arrangement to help the states stretch out and meet their obligations to these mighty bondholders, and otherwise give them some kind of assistance—- the stimulus money saved the states in 2009-10, after all. Of course, this rescue will happen only if the Republicans are not in charge in Congress.  And,

*Third, if we cut military spending and re-instituted some of the former taxes on the super-wealthy, there would be a lot of money available for other things, now wouldn’t there?