In recent history, the United States has survived at least three major financial debacles: the Savings & Loan crisis around 1990, the bursting of Internet bubble around 2000, the collapse of the real estate bubble that began in 2007. What’s next? When I was writing “Boomergeddon” earlier this year, I expected the next traumatic financial event to be the default by the United States and other sovereign nations on their debt. But I didn’t see the U.S. hitting the skids until the mid-2020s.
Meredith Whitney, the superstar financial analyst who first warned how the real estate crash would create a disaster for U.S. banks, now warns of a looming sovereign debt crisis — but the sovereigns she refers to are not Greece, Ireland or Portugal. They are California, New Jersey, Illinois and Ohio.
In a new 600-page report (which I am trying to lay hands on), she argues that the next systemic risk in U.S. finance is state and municipal government. In an interview with CNBC, she said she sees scary parallels between the fiscal condition of states/municipalities and the banks, including widespread off balance-sheet borrowing and a lack of transparency. Indeed, no one — including the bond-rating geniuses at Moody’s, Standard Poor’s and Fitch, I might add — had compiled all the information she believes is necessary to truly understand the risk. So, she set the staff of her boutique firm onto the job. “The Tragedy of the Commons” is the result.
Fortune magazine has the best coverage of the report. Whitney rates the condition of the nation’s largest 15 states (as measured by GDP) on four criteria: their economy, fiscal health, housing and taxes. Only two states — Texas and Virginia — get positive ratings. The states with the worst ratings are, in order of awfulness:
California
New Jersey, Illinois, Ohio (tie)
Michigan
Georgia
New York
Florida
The middling states are Washington, North Carolina, Pennsylvania, Maryland and Massachusetts.
There is a giant gap between the states’ spending and tax revenues, which she estimates at $192 billion, or 27% of their budgets, for fiscal 2010. That pressure will continue building, especially upon municipalities that rely upon property tax revenues, as real estate market continue to implode. Whitney expects the states to look after their own finances first, leaving many cities to fend for themselves. Accordingly, she expects municipalities could start defaulting on bonds in large numbers.
The worst-off jurisdictions are states and municipalities where housing prices grew the fastest, tax revenues and spending soared, and local governments borrowed heavily to finance the growth. The collapse of housing prices and property tax revenues leaves them the most exposed.
The Obama stimulus package gave states a reprieve in fiscal 2010 by making up roughly one-third of their budget shortfall. On CNBC, Whitney speculated that there will be intense political pressure in Congress for another bail-out, but that would simply transfer liabilities to the federal government, which has its own balance sheet issues, and create even more moral hazard.
The Old Dominion may be better off than most other big states, but that is no reason for Virginians to rest on our laurels. No one to my knowledge (other than Whitney, perhaps) has recently calculated how much debt Virginia’s cities, counties and independent authorities collectively have accumulated. And no one has carefully examined the consequences of still-falling real estate prices on the ability of Virginia municipalities to carry that debt. We may be OK. But, then, we might not be. It should be a top priority of Gov. Bob McDonnell’s commission on government reform and restructuring to find out
