Dec 28. US States’ fiscal woes threaten to blunt Fed stimulus

As an example of fiscal woes plaguing state and local governments, consider the state of Illinois.  State and local governments comprise about 13% of GDP, so the crunch in this sector is likely to blunt the effects of federal stimulus measures that were recently enacted.  All sorts of fees and taxes have been rising, but in the case of Illinois, proposals to raise the income tax have so far floundered, with Governor Pat Quinn aiming for an increase of 1%, from 3% to 4%.  In other words, tax increases and budget cuts are yet to come in many states, and the end of the Build America Bond program is another headwind for state budgets in 2011.  In June of 2010, Moody’s downgraded IL debt from Aa3 to A1, saying the state lacks the political will to deal with fiscal problems. 

As of the end of 2008, IL was the 5th largest state as a contributor to US GDP at 4.5%, in an amount of $634B.  The larger states are CA, TX, NY and FL, with CA at around 13% of US GDP.  Besides TX, all of the above states are in bad fiscal shape, for many of the same reasons: falling tax revenues accentuated by the drop in real estate values, and unpaid pensions. 

In IL, one issue that has begun to garner increasing (negative) publicity is the pile of unpaid bills owed to vendors of all types. These liabilities are apparently in the staggering amount of between $6 and $8 B.  In 2008 the unpaid bill backlog was $512 million.  The Chicago Tribune reports today (Dec 28, 2010) http://www.chicagotribune.com/news/local/ct-met-governor-quinn-20101227,0,6073116.story that Gov Pat Quinn is looking at floating a $15B bond issue to cover unpaid bills.  From the article,  “Those the state owes now get 1 to 2 percent in interest for each month payments are late after the first 60 days.”  My understanding is that 2% is only in special circumstances, but at 1% the state is losing $60 million per month in extra interest and penalties at a minimum.  If the bond float passes, I would guess the state could save at least $30 million per month in cheaper interest. 

Another (much less publicized) step the state has taken to deal with unpaid bills was noted in the Huffington Post  http://www.huffingtonpost.com/david-ormsby/governor-pat-quinn-is-mov_b_798455.html and on the website Illinoisisbroke.com http://www.illinoisisbroke.com/newsitem.aspx?id=673 as reported November 15, 2010.  The idea (which was done in small size in a pilot program) “allowed a handful of vendors to sell financial institutions the rights to their overdue payments.”  It is basically a collection agency arrangement made with the blessing of the state.  The structure of the deal is that the “investor” or buyer of the rights, immediately pays the vendor 90% of the amounts owed, with 10% held in escrow.  The investor receives the accruing penalty interest payments directly from the state (eventually), and then the other 10% is released to the vendor.  So the vendors forfeit the extra interest in order to get immediate cash flow for survival.  From the HuffPost article: “I applaud Governor Quinn’s clever initiative to pay overdue bills owed to human service providers and other state vendors without adding to the state’s debt,” said State Rep. Sara Feigenholtz (D-Chicago), the Chair of the House Human Services Appropriations Committee. “This program will rescue many social service providers operating on the edge of financial extinction.” 

The previous quote, while true in terms of possibly saving vendors that are swirling the toilet bowl because they can’t cover their costs without cash flow, shows willful ignorance by asserting the state is not adding to debt.  The state already HAS the debt, and is paying PUNITIVE interest rates.  If that’s “clever” then I would hate to find out what Ms Feigenholtz considers “stupid”.  The questions that naturally arise might be 1) if we pass the bond issue can we tie it to a proposal to pay all unpaid bills IMMEDIATELY with NO INTEREST or PENALTIES?  Why can’t the state negotiate those terms directly with vendors?  2) if investors are willing to accept lower interest payments on Illinois bonds, can the state negotiate lower payments than 1% per month directly with those investors who assume the unpaid bill debt?  In my opinion, the state of Illinois is guilty of gross financial misconduct, but I suppose that shouldn’t be a surprise, since several former governors have been sent to jail. 

The other huge issue facing IL and other states concerns unfunded pension liabilities.  According to an article by Mish Shedlock http://globaleconomicanalysis.blogspot.com/2010/04/interactive-map-of-public-pension-plans.html IL unfunded pensions are at least $209 billion.  At least two plans, for the Universities and the Teachers Retirement System are less than 30% funded.  That’s a pretty large chunk of money relative to GDP of $634 billion.  I’m not sure if the two numbers are exactly current, but I would safely guess that IL GDP isn’t significantly higher than it was in 2008. 

The point is that several large US states are facing fiscal problems similar to european countries, and the crunch of budget cuts and increased taxes/fees will occur in 2011 as a direct and opposite force to federal stimulus.

Posted on December 28, 2010 at 10:48 am by alexmanzara · Permalink
In: Eurodollar Options

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