Examiner Editorial: States face crisis when federal funds dry up

Meredith Whitney isn’t exactly a household name, but she’s as famous as Cassandra on Wall Street. That’s because in 2007, Whitney was one of the first to note that Citigroup and other high-flying banks were on the verge of collapse.

Now the same woman who predicted the Wall Street meltdown is warning about another calamity: Our state governments are going broke, with possibly disastrous consequences.

“I see a lack of transparency and an abundance of complacency on the part of investors and politicians, just as we saw before the banks imploded,” she recently told Fortune magazine.

Whitney released a 600-page report on states’ fiscal woes, warning of $192 billion in budget shortfalls, which comes to 27 percent of all combined state budgets for the 2010 fiscal year. States have been borrowing heavily from health care and public pension funds, which are now underfunded by $1 trillion, to cover their debts. What happens when states can’t pay the bills?

The next step is a collapse in the municipal bond market because American cities and towns get about one-third of their revenue from states. When the states run out of money, cities around the country could default. For example, Pennsylvania recently bailed out the city of Harrisburg, whose debt-service payments currently exceed its annual budget. What happens if multiple cities follow this path at once and the states lack resources for multiple bailouts?

This possibility is not remote: A handful of California towns with serious budget problems have either filed for or are exploring Chapter 9 bankruptcy. More may follow if the economy remains in the ditch, precipitating an even-worse disaster. A glut of municipal defaults could force cities everywhere to pay exorbitant interest rates to borrow in the future, creating a need for much higher state and local taxes just to maintain current government services.

Whitney’s report pinpoints the reason municipal bond markets are so precarious right now: State and local governments have been using federal funds to live beyond their means. The stimulus bill, for example, is covering $60 billion of the states’ shortfall this year, but that money won’t be around next year.

The feds, already in the hole by $14 trillion, cannot keep up the state bailouts indefinitely. We face dire economic consequences if we don’t end the fiscal hegemony of the federal government. The question is, will anyone listen to Whitney?

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