13 July 2009

State of Fear

State governments are in even more trouble than they seem to be. Here's how to save them.

By Eliot Spitzer

For those who were worried that Wall Street had perhaps lost its creative juices after its recent spasm of busts and bailouts, fear no more. At the beginning of the month, California ran out of cash and began issuing funny-money IOUs to its creditors. As soon as that happened, the smart guys on Wall Street created a whole new market trading the IOUs. No doubt the IOUs will soon be bundled into more exotic financial instruments, which will be cut up into tranches, graded lazily by the ratings industry, and sold off to unsuspecting investors in Abu Dhabi and Helsinki.

What a perfect metaphor for our economic circumstances! California is literally drowning in red ink and political gridlock, with deficit figures that are staggering and portend worse news for the future at the same time that a bailed-out Wall Street is profiting from a new, and essentially useless, trading vehicle.

But the worse news is that what we are seeing in California is what other states—perhaps most of them—will go through soon. States are being squeezed in two directions. Rapidly declining tax revenues are creating short-term cash flow crises. Meanwhile, their long-term pension obligations are rising rapidly, even as the pension funds that were supposed to cover them have been devastated by the Wall Street decline, creating enormous long-term unfunded liabilities. These two forces are creating both short-term and long-term pain for states.

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