State deficits are the next powder keg and yet the market pretends all is fine

Some state and local governments are so

distressed that some analysts say they are

reminded of the run-up to the subprime

mortgage meltdown or of the debt crisis

hitting nations in Europe.

New York Times
12/4/10
By Michael Cooper and Mary Williams Walsh

The State of Illinois is still paying off billions in bills that it got from schools and social service providers last year. Arizona recently stopped paying for certain organ transplants for people in its Medicaid program. States are releasing prisoners early, more to cut expenses than to reward good behavior. And in Newark, the city laid off 13 percent of its police officers last week.

While next year could be even worse, there are bigger, longer-term risks, financial analysts say. Their fear is that even when the economy recovers, the shortfalls will not disappear, because many state and local governments have so much debt — several trillion dollars’ worth, with much of it off the books and largely hidden from view — that it could overwhelm them in the next few years.

But the finances of some state and local governments are so distressed that some analysts say they are reminded of the run-up to the subprime mortgage meltdown or of the debt crisis hitting nations in Europe.

Analysts fear that at some point — no one knows when — investors could balk at lending to the weakest states, setting off a crisis that could spread to the stronger ones, much as the turmoil in Europe has spread from country to country.

Mr. Rohatyn warned that while municipal bankruptcies were rare, they appeared increasingly possible. And the imbalances are so large in some places that the federal government will probably have to step in at some point, he said, even if that seems unlikely in the current political climate.

“I don’t like to play the scared rabbit, but I just don’t see where the end of this is,” he added.

Resorting to Fiscal Tricks

As the downturn has ground on, some of the worst-hit cities and states have resorted to fiscal sleight of hand to stay afloat, helping them close yawning budget gaps each year, but often at great future cost.

Few workers with neglected 401(k) retirement accounts would risk taking out second mortgages to invest in stocks, gambling that the investment gains would be enough to build bigger nest eggs and repay the loans.

But that is just what Illinois, which has been failing to make the required annual payments to its pension funds for years, is doing. It borrowed $10 billion in 2003 and used the money to invest in its pension funds. The recession sent their investment returns below their target, but the state must repay the bonds, with interest. The solution? Illinois sold an additional $3.5 billion worth of pension bonds this year and is planning to borrow $3.7 billion more for its pension funds.

“It seems to me that crying wolf is probably a good thing to do at this point,” said Felix Rohatyn, the financier who helped save New York City from bankruptcy in the 1970s.

Some of the same people who warned of the looming subprime crisis two years ago are ringing alarm bells again. Their message: Not just small towns or dying Rust Belt cities, but also large states like Illinois and California are increasingly at risk.

Municipal bankruptcies or defaults have been extremely rare — no state has defaulted since the Great Depression, and only a handful of cities have declared bankruptcy or are considering doing so. NY Times Complete Article and so worth the read!



Report warns of coming wave of municipal pension shortfalls

By Michael A. Fletcher
Washington Post Staff Writer
10/12/10

The nation's largest municipal pension plans are carrying a total unfunded liability of $574 billion, which comes on top of as much as $3 trillion in unfunded pension promises made by the states, according to a report released Tuesday.

The report calls the unfunded pension obligations "off-the-balance-sheet debt" that threatens to starve services such as police protection, recreation centers, parks and libraries.

"The ability of local governments, particularly cities, to provide the levels of service they do now is threatened by this liability," said Joshua Rauh, a Northwestern University business professor who co-authored the report with Robert Novy-Marx, a University of Rochester professor.

The report is based on an analysis of pension funds in 50 major cities and counties that together account for two-thirds of the nation's 3 million local government employees. It argues that cities routinely cling to unrealistic projected investment earnings to understate their pension liabilities, a strategy that has been exposed by the financial crisis and recession, which severely diminished investment returns.

The result is a growing wave of pension shortfalls that threatens to wash over many local governments in the near future, the report said. The authors calculated that each household in the 50 cities and counties they studied owes an average of $14,165 to current and past government employees for their pensions.

The report says that five major cities -- Boston, Chicago, Cincinnati, Jacksonville and St. Paul -- have pension assets that can pay for promised benefits only through 2020.

Philadelphia, for example, has assets on hand that can only pay pension promises through 2015, the report says. But that assertion is disputed by some Philadelphia pension officials.

"Unless someone has a crystal ball, they have no idea what the future holds in the markets," said Bill Rubin, vice chairman of the city's $4.2 billion pension fund. "We can meet our obligations and we have a plan in place to be able to meet our obligations in the future."

Philadelphia Mayor Michael A. Nutter (D) has declared unsustainable the city's tradition of offering guaranteed pensions to employees and said he wants to replace pensions with defined-contribution plans such as 401(k)s, raising the hackles of municipal employee unions.

Rauh, who previously completed a report that pegged the pension liability of states at $3 trillion, says the mounting debt crisis is going to force major changes on public pension plans sooner or later.

He says cities and counties should trim benefits by raising retirement ages for plan participants and lowering cost-of-living adjustments. Once promises are curtailed, he said the debt can be refinanced and spread out into the future. He added that new employees should not be given guaranteed pensions, and instead be shifted to defined-contribution plans.

"We need fundamental reform of the ways employees in the public sector are compensated," Rauh said. "It is not feasible to make promises of risk-free pensions when in the private sector [nearly] everyone has to share some of the risk."