by Wolf Richter, Wolf Street:
Moral Hazard Spreads: TBTF States?
During the Financial Crisis, it was California that made the headlines with “out-of-money dates” and fancy-looking IOUs with which it paid its suppliers. The booms in the stock market and the startup scene – the state is desperately hooked on capital-gains tax revenues – but also housing, construction, etc. sent a flood of moolah into the state coffers. Now legislators are working overtime to spend this taxpayer money. Gov. Jerry Brown is brandishing recession talk to keep them in check. Everyone knows: the next recession and stock-market swoon will send California back to square one.
Now Puerto Rico is in the headlines. It’s not even a state. And it’s relatively small. But look at wild gyrations by the federal government and Congress to deal with it, to let the island and its bondholders somehow off the hook.
But Puerto Rico may just be the model. Big states are sliding deeper into financial troubles, particularly New Jersey, Connecticut, and Illinois.
These three states hold the top positions in the “Zombie Index” that Bill Bergman, Director of Research at Truth in Accounting, developed two years ago. California has dropped to 7th place. Whew!!!
The Zombie Index for the 50 states is based on three main factors:
Truth in Accounting’s “Taxpayer Burden” measure of state finances
The timeliness of state financial reporting
And the share of total debt effectively “hidden” off the balance sheet.
This “taxpayer burden” is not a reflection of actual state taxes paid, but of the state’s total liabilities per taxpayer – such as outstanding bonds and loans and off-balance-sheet liabilities such as for pensions.
In explaining the Zombie Index, Bergman writes in his article, “Zombie states deteriorating faster and further”:
The index is named after a term coined by Ed Kane, professor of finance at Boston College. Kane wrote two books warning us about the S&L crisis back in the 1980s and early 1990s, before we knew what hit us. Kane used the term “zombie bank” to identify insolvent firms that were allowed to stay open by regulators, frequently with the aid of false regulatory accounting principles that delayed the recognition of insolvency.
Many of these firms ended up “gambling for resurrection,” in Kane’s terms, and these incentives ended up trebling the cost of the S&L crisis when many gambles went sour.
In an article two years ago, when Bergman introduced the Zombie index, he wrote:
Kane’s careful history indicates that this risky behavior and the financial conditions of these zombie banks were hidden by less-than-truthful accounting practices. There are alarming parallels to the financial crises faced by many state and local governments today.
These questionable accounting practices have allowed hundreds of billions of dollars of pension debt to accumulate outside governments’ audited balance sheets.
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