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Worst “Zombie States” in America “Deteriorate Faster, Further”

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.

Read More @ WolfStreet.com

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1 comment to Worst “Zombie States” in America “Deteriorate Faster, Further”

  • rich

    California Treasurer Chiang’s Private Equity Transparency Three Card Monte
    Posted on June 24, 2016 by Yves Smith

    We held our fire on the progress of California Assembly bill AB 2833, a private equity fee transparency bill, in the hope that its sponsor, Treasurer John Chiang, who sits on the CalPERS and CalSTRS boards, was acting in good faith.

    In fact, AB 2833 was amended on Wednesday so as to be so pointless that we oppose the bill and urge California readers to call and write their representatives to urge them to vote against it in its current form.

    Worse, it’s obvious that Chiang and his staff merely used this bill as an opportunity for the Treasurer to pretend to be on the right side of the growing consternation over ignorance of limited partners like CaLPERS of the full fees and costs of investing in private equity, which come at the expense of their beneficiaries.

    This bill has the hallmarks of cynical ploy. Chiang was not only unwilling to stand up against the private equity industry. He failed even to make a pretense of standing up to their stooges, the captured California public pension funds. Not only did he fail to put up a fight for having the bill deliver on its promise, he never took basic, pro-forma steps to advocate for it.

    The initial bad sign was when the stewardship of the bill through the legislature was orchestrated to assure that only insiders, meaning captured public pension funds acting as stooges for the private equity industry, had input into the sausage-making.

    But even worse, as we’ll show next week, at a recent CalPERS board meeting, Chiang’s staffer, Grant Boyken, flagrantly misrepresented the status of the bill as the board was debating what action to take with respect to AB 2833. As a result of this gamesmanship, the board gave blanket approval to the measure when it had been advised that amendments were pending but was kept in the dark as to what they might be. And in fact, Chiang and Boyken knew what was pending; a draft was circulating at that time that is virtually identical to the key changes that were just made.

    Today, we will discuss the deficiencies of the bill as it stands. Next week, we will show how Chiang failed to make a serious go at implementing real reform.

    What Chiang Promised Versus What the Bill Delivers

    In other words, Chiang was concerned that investors are paying unjustifiably high fees to private equity firms.

    Recall also that a few months earlier, Ching along with a dozen other prominent public pension fund trustees wrote the SEC to intervene on behalf of these investors. One of the ruses they flagged was the way that general partners circumvent disclosure is by having the companies they control make payments to them or to related parties. That means the monies do not flow through the investment fund and are not reported as costs in the investment fund’s audited financial statements.
    Worse,some of these fees, like monitoring fees, are purely extractive; Oxford Professor Ludovic Phalippou has called them “money for nothing.” Others are set well above any defensible value for the service rendered. For example, many general partners charge “transaction fees” at the level that investment banks charge, when they also have engaged an investment bank to do the actual work.

    http://www.nakedcapitalism.com/2016/06/california-treasurer-chiangs-private-equity-transparency-three-card-monte.html

    they get wealthy sucking the masses dry

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