Meredith Doubles Down: Move Over Munis, Here Comes The "Hidden State Financial Crisis"

Tyler Durden's picture

There are those who thought that following the material pushback by every chatterbox on CNBC that the muni situation is actually nice to quite nice, contrary to what Meredith Whitney had prophesied, that the scourge of Citi would slink back into whatever hole it is she crawled out of. And then there is Meredith Whitney, whose occasional appearances on TV have resulted in 25 weeks of consecutive, and material outflow from municipal funds. Undaunted by her critics, she has now doubled down, and shifting away from munis, is now focusing one level higher: on the state financial crisis. Her conclusion, sure to set off a firestorm of angry responses tomorrow when the Op-Ed hits the print version of the WSJ: "Defaults in a variety
of forms by states and municipalities are already happening and more
are inevitable. Taxpayers have borne the initial brunt of these defaults
by paying higher taxes in exchange for lower social services. And state
and local government employees are having to renegotiate labor
contracts that they once believed were sacrosanct." And sure enough, she refuses to abandon her muni thesis: "Municipal bond holders will experience their own form of contract
renegotiation in the form of debt restructurings at the local level.
These are just the facts. The sooner we accept them, the sooner we can
get state finances back on track, and a real U.S. economic recovery
underway." Yes, well, one can argue that the sooner Ms. Whitney accepts that the modus operandi in the developed world is to preserve the status quo no matter the cost, and kick the can down the road indefinitely, the sooner we can all get back to a state of vegetative existence in which nobody questions anything and the world is one swell place until everything blows up.

Meredith Whitney: The Hidden State Financial Crisis, posted in the WSJ

Next month will be pivotal for most states, as it marks the fiscal
year end and is when balanced budgets are due. The states have racked up
over $1.8 trillion in taxpayer-supported obligations in large part by
underfunding their pension and other post-employment benefits. Yet over
the past three years, there still has been a cumulative excess of $400
billion in state budget shortfalls. States have already been forced to
raise taxes and cut programs to bridge those gaps.

Next month will also mark the end of the American Recovery and
Reinvestment Act's $480 billion in federal stimulus, which has
subsidized states through the economic downturn. States have grown more
dependent on federal subsidies, relying on them for almost 30% of their
budgets.

The condition of state finances threatens the economic recovery.
States employ over 19 million Americans, or 15% of the U.S. work force,
and state spending accounts for 12% of U.S. gross domestic product. The
process of reining in state finances will be painful for us all.

The rapid deterioration of state finances must be addressed
immediately. Some dismiss these concerns, because they believe states
will be able to grow their way out of these challenges. The reality is
that while state revenues have improved, they have done so in part from
tax hikes. However, state tax revenues still remain at roughly 2006
levels.

Expenses
are near the highest they have ever been due to built-in annual cost
escalators that have no correlation to revenue growth (or decline, as
has been the case recently). Even as states have made deep cuts in some
social programs, their fixed expenses of debt service and the
actuarially recommended minimum pension and other retirement payments
have skyrocketed. While over the past 10 years state and local
government spending has grown by 65%, tax receipts have grown only by
32%.

Off balance sheet debt is the legal obligation of the state to its
current and past employees in the form of pension and other retirement
benefits. Today, off balance sheet debt totals over $1.3 trillion, as
measured by current accounting standards, and it accounts for almost 75%
of taxpayer-supported state debt obligations. Only recently have states
been under pressure to disclose more information about these
liabilities, because it is clear that their debt burdens are grossly
understated.

Since January, some of my colleagues focused exclusively on finding
the most up-to-date information on ballooning tax-supported state
obligations. This meant going to each state and local government's
website for current data, which we found was truly opaque and without
uniform standards.

What concerned us the most was the
fact that fixed debt-service costs are increasingly crowding out state
monies for essential services. For example, New Jersey's ratio of total
tax-supported state obligations to gross state product is over 30%, and
the fixed costs to service those obligations eat up 16% of the total
budget. Even these numbers are skewed, because they represent only the
bare minimum paid into funding pension and retirement plans. We
calculate that if New Jersey were to pay the actuarially recommended
contribution, fixed costs would absorb 37% of the budget. New Jersey is
not alone.

The real issue here is the enormous over-leveraging of
taxpayer-supported obligations at a time when taxpayers are already
paying more and receiving less. In the states most affected by
skyrocketing debt and fiscal imbalances, social services continue to be
cut the most. Taxpayers have the ultimate voting right—with their feet.
Corporations are relocating, or at a minimum moving large portions of
their businesses to more tax-friendly states.

Boeing is in the political cross-hairs as it is trying to set up a
facility in the more business-friendly state of South Carolina, away
from its current hub of Washington. California legislators recently went
to Texas to learn best practices as a result of a rising tide of
businesses that are building operations outside of their state. Over
time, individuals will migrate to more tax-friendly states as well, and
job seekers will follow corporations.

Fortunately, many governors are addressing their state's structural
deficits head on. Unfortunately, there is a lack of collective
appreciation for how painful this process will be. Defaults in a variety
of forms by states and municipalities are already happening and more
are inevitable. Taxpayers have borne the initial brunt of these defaults
by paying higher taxes in exchange for lower social services. And state
and local government employees are having to renegotiate labor
contracts that they once believed were sacrosanct.

Municipal bond holders will experience their own form of contract
renegotiation in the form of debt restructurings at the local level.
These are just the facts. The sooner we accept them, the sooner we can
get state finances back on track, and a real U.S. economic recovery
underway.