When Meredith Whitney speaks, Wall Street listens. Whitney is the financial analyst who first warned that the real estate crash spelled disaster for the U.S. banking system. In a new, 600-page report, “The Tragedy of the Commons,” she sounds the alarm for a second-wave financial crisis afflicting state and local government.
Whitney sees scary parallels between the fiscal condition of states/municipalities and the banks, including excess leverage, off balance-sheet financing, and a lack of transparency. As falling real estate values continue to undermine property tax revenues, and as federal stimulus funds dribble to a halt, she says, heavily indebted municipal governments will find themselves in deep trouble.
Two of the 15 states studied — Texas and Virginia — get positive ratings under Whitney’s rating system. That is reason for Virginians to take some grim satisfaction but no excuse to get complacent. We have issues galore to deal with, including rising Medicaid costs, schools that don’t teach, $620 million owed to the state retirement system, and a transportation-funding mechanism in worse repair than Interstate 95′s creaky bridges. Unlike previous economic recoveries, in which gushing revenues replenished state treasuries, Virginia will enjoy little respite from fiscal stress in the decade ahead.
The years of plenty have passed. The years of hardship are upon us. We can no longer afford government-as-usual. We cannot tinker on the budgetary margins with incremental process reforms and tweaks to line items. We must thoroughly rethink how we deliver government services. If we fail to do so, circumstances will force the harsh decisions upon us.
Even as Virginia’s lawmakers grapple with short-term challenges, they should not overlook a formidable long-term threat to the state’s fiscal well-being: a federal government hurtling toward its own ignoble demise. As I argue in my book Boomergeddon, by the mid-2020s, the federal government itself will be so deeply indebted that it is highly likely to go into default. Uncle Sam then will face a budget gap equal to some 40 percent of the budget, which it will try to close through some combination of cutting spending, raising taxes, repudiating the debt, or cranking up the printing presses. The result will be economic chaos, if not another Great Depression-style meltdown.
To some, the idea that the federal government faces default within 15 years smacks of “deficit hysteria.” But look at the facts. Even the Obama administration’s own 10-year budget forecast projects that annual deficits will never shrink below $700 billion, and that the national debt will increase by $8 trillion — to $21 trillion — by 2020. The International Monetary Fund declares that the ratio of U.S. debt to the size of its economy will reach 110 percent by 2015, about the same as Greece’s when its debt woes sparked Europe’s sovereign debt crisis.
Moreover, President Obama’s forecast is based upon a number of optimistic assumptions, not the least of which is that Congress will stop spending money like a Valley Girl with daddy’s credit card. Making a different set of likely tax and spending assumptions, the non-partisan Concord Coalition sees total debt exceeding $28 trillion by 2020.
Obama’s economic growth forecasts are shaky, too. His 10-year projection assumes economic growth averaging 3.4 percent annually, with no recession — an economic performance comparable to the Internet-fueled boom of the Clinton years. But there is no sign of a boom in the making. Indeed, the U.S. will be fortunate to avoid a double-dip recession. Plugging different growth assumptions into the Obama model — 1 percentage point slower economic growth through the decade, plus a mild recession toward the end — yields a national debt of $29 trillion by 2020.
Likewise, the Obama budget model is highly sensitive to changes in interest rates. The president’s number crunchers assumed that interest rates on 10-year Treasuries will never climb higher than 5.3 percent during the 2010s. But if 10-year bonds returned to the rate of the early 1990s, around 10 percent, the national debt could exceed $36 trillion! If the federal government somehow survives the gantlet of the 2010s, it then faces the wave of 78 million retiring boomers as well as the drawdown of Social Security’s (anticipated) $4.3 trillion trust fund, forcing the Treasury to borrow trillions more.
Per capita federal spending in Virginia is seventh highest in the nation. When Uncle Sam defaults, Virginia will feel the anguish more than most. The commonwealth must begin now preparing for that day. Gov. Bob McDonnell’s Commission on Government Reform and Restructuring is a good place to start. But it will take a lot more than privatizing ABC stores to diversify the economy and bullet-proof the commonwealth’s finances.
(This column was first published in the Richmond Times-Dispatch.)
