The Three-Way Race To The Bottom

July 8, 2010

by Al Doyle

Who doesn’t enjoy a close, exciting ballgame or race where the outcome is in doubt until the last possible moment? Something similar is taking place in the U.S. economy, and the results could lead to much devastation.

Every state constitution but Vermont’srequiresannual budgets to be balanced. This nod to financial prudence hasn’t prevented 46of the 50 states from facing budget deficits in 2010, and three states in particular stand out as potential economic time bombs.

This trio of financial basket cases – California, Illinois and New York – all have large numbers of welfare recipients, left-leaning governments that despise liberty, political cultures where corruption and graft thrive, and an addiction to high taxes and big spending. Not surprisingly, these are the states that are closest to the edge of the cliff as Great Depression II unfolds.

As bad as New York’s estimated $9.2 billion deficit and confiscatory tax rates are (including a 3.65 percent city income tax for high-earning residents of New York City), the Empire State does no better than third place on the list of potential disasters, and that speaks volumes about the money woes in California and Illinois.

California’s troubles have been widely reported, and the media has laid out a thorough analysis of the state’s crisis. The budget deficit is estimated to be somewhere between $19 and $21 billion, and there is little disagreement with those numbers. Despite this monstrous lack of funds, politicians in both parties have shown little will or inclination to make more than minor cuts in an out-of-control state budget.

Since a new state budget wasn’t passed by June 30, California governor Arnold Schwarzenegger cut wages to the federal minimum of $7.25 an hour for the vast majority of the state’s 200,000 employees. The lostearnings are supposed to be paid in full when a budget is approved, but no one knows when that will happen.

California cities – especially Los Angeles – have their own fiscal crises that are very similar to what is happening at the state level, and that only intensifies the situation. The L.A. suburb of Maywood serves as a microcosm for California.

The city of 27,000 laid off all municipal employees and closed the police department on June 30. Services and police protection were contracted out to neighboring towns and the county sheriff’s department. At least 40 percent of Maywood residents are illegal aliens. The town is a hotbed of La Raza activists, and Maywood’s finances were decimated by widespread wasteful spending, graft, and corruption.

With that many financial crises, California will surely be the first U.S. state to declare bankruptcy ... you would think. But Illinois may be in even worse shape.

That state currently has more than $5 billion in unpaid bills and overdue payments to school districts, cities and service providers. “This is what the state owes right now to schools, rehabilitation centers, child care, the state university – and it’s getting worse,” admits Illinois comptroller Daniel W. Hynes.

Pension plans for state employees have been severely underfunded for at least 15 years. Illinois is currently funding pensions at somewhere around 50 to 60 percent of what is needed to meet actuarial guidelines. The shortfall is so deep that governor Pat Quinn has floated the idea of borrowing $3.5 billion to pay pensions for a year. Even without the pension crisis, Illinois is facing a potential deficit of $12 billion.

The state’s infamously corrupt political culture (former governor Rod Blagojevich’s current trial for racketeering and extortion is hardly considered unusual for Illinois governors) means countless billions have been squandered and stolen over the years. As with other states, legislators show little inclination to make wholesale reductions in government spending that are desperately needed.

No state wants to be the first to officially go bankrupt, as that mark of irresponsibility will be remembered for decades. When Illinois (MIA’s pick to lead the way), California, or another state goes belly up, it will set off a chain reaction of similar defaults that will deal a major blow to the bond market. In this case, the only question is when – not if.