It's been 25 years since state and local governments across the United States were in such bad shape – and the budgetary pain is far from over.
The state-funding gap is growing, local governments lost 76,000 jobs last month, and property tax receipts are slated to fall for years.
"While the recession might have officially ended on the national level, cities are in the eye of the storm and the problems are intensifying," Christopher Hoene, a director at the National League of Cities, told The Financial Times.
A study released this week showed that big U.S. cities could face a painful financial squeeze: Their pension plans are under-funded to the tune of $547 billion.
And that's only part of a very ugly public-pension picture. State-run pensions are believed to have unfounded liabilities of $3 trillion, according to research by Kellogg School of Management at Northwestern University and the University of Rochester.
Of the 50 cities and counties studied, Philadelphia is in the worst shape, with only enough assets to pay benefits in current pension plans through 2015. Boston and Chicago would run out of money by 2019.
Another recent study by the Citizens Budget Commission of New York measured states' financial obligations against their economic resources. The study gave New Jersey the worst ranking, although the fiscal outlooks for New York, California, Illinois and Rhode Island are almost as dismal.
Because states and cities didn't keep their financial houses in order, taxpayers can look forward to years of tax increases, service cuts and other slick tricks to foot the bill for unfounded pension obligations. And that bleak outlook could actually exacerbate the situation and accelerate urban flight by pushing many current urban residents to head for "greener" (read that to mean suburban) pastures – further eroding city tax bases.
"The fact that there is such a large burden of public employee pensions concentrated in urban metropolitan areas threatens the long-run economic viability of these cites, as residents can potentially move elsewhere to escape the situation," Joshua Rauh of the Kellogg School told The FT.
The truly frightening state of local government finances is sparking heightened concern for municipal bond investors.
Investors are scrutinizing "munis" more than ever – and with good reason: Some governments have masked their budgetary woes through such creative accounting methods as borrowing money for operational needs, moving money from task-dedicated funds to general funds, and pushing vendor payments into future fiscal years.
And those employed tactics aren't presented to bond investors.
"The long-running use of gimmicks is part of the reason most state budgets are in crisis today," George Mason University's Eileen Norcross wrote in a recent study cited by The Wall Street Journal.
Take Illinois, which presented a $10 billion bond offering in 2003 and used extensive borrowing to make its pensions appear well funded. Then the state skipped contributions for years, and now a Northwestern University study projected that Illinois's pension system could run out of money in the next decade.
Money Morning Contributing Editor Martin Hutchinson warned investors in July to avoid the muni sector, citing the exorbitant state budget shortfalls.
"[I]t seems hopelessly unlikely that all the vulnerable states – and there are perhaps a dozen with considerable degrees of vulnerability – will be able to save themselves this time around," said Hutchinson. "And this will all come back to bite investors."
While bondholders often think they get first dibs on government funds, getting paid in a fiscal crisis will not be as easy as they hope.
As Kellogg's Rauh noted: "The bondholders would be competing with the pension beneficiaries for scarce government resources."
This brings us to next week's Money Morning "Question of the Week": Are you vulnerable to this state-and-local government budgetary squeeze? Have you seen – or are you expecting – spending and service cuts and big tax increases? Is your retirement tied to this public-sector-finance disaster? Would you consider switching jobs, or perhaps even moving to escape this public-budgetary fallout? Finally, as an investor, do you trust municipal bonds, or are you now avoiding them?
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News and Related Story Links:
- Money Morning:
Defensive Investing: Beware of Municipal Bonds
- Financial Times:
US cities face big public pension deficits
- Financial Times:
US cities feel tax hit on real estate bust
- The Wall Street Journal:
How States Hide Their Budget Deficits
- Money Morning News Archive:
Question of the Week Feature