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A COLUMN BY MICHAEL HICKS

State and municipal bankruptcies are the financial crisis around the corner

Tuesday, November 13, 2012 - 12:01 am

President Obama faces an impending crisis that is as bad, if not worse, than the national debt, which will itself take a long generation to remedy. I write, of course, about the potential for widespread bankruptcies of perhaps dozens of municipalities and the effective bankruptcy of at least three and as many as a dozen states. This will present historic difficulties for the nation, and much will depend on effective leadership from the president.

Today, a slow drip of municipal bankruptcy is spreading across the nation, 28 in the last two years alone, with only about half of states authorizing such steps, and hundreds more bankruptcy or bankruptcy-like steps are under serious consideration. If this weren't bad enough, bond markets have already identified two states that cannot possibly pay their obligations, and a further four that are in serious trouble. Worse still, beginning in 2014 state and local governments will be required to report their pension obligations like businesses currently must. This means that sometime in the next fiscal year the debt that is several times greater than that which is currently on the books will magically appear on balance sheets. Among the worst examples will be Illinois, where reported government liabilities will rise from a few thousand dollars per resident to as much as $100,000 per citizen. No government without the ability to print money can pay this amount, and this will generate a crisis that will test the republic.

On its face, the problems should be easy to fix. Government employees in many places have been made promises that cannot be kept. These are mostly about pension benefits such as compensation, retirement age and health care costs. In the most solvent places, such as Indiana, this will mean modest benefit cuts to teachers and public employees. It will also mean higher tax rates than we would otherwise have enjoyed. In Chicago, New York and Los Angeles it will mean fiscal chaos that is outside of modern memory. This will lead to calls for federal interventions, which must be largely resisted.

The federal government has had to deal with failed states in the past. The great unpleasantness of 1861-1865, the Great Depression and the Civil Rights Era are three examples. We have had to watch states who are unable to pay their bills, but that was when state budgets were small and state services minimal. One need only conjure the names of Lincoln, Roosevelt, Eisenhower, Kennedy and Johnson to apprehend the strength needed to deal with this crisis. I am much worried.

It is telling that the grade failures will occur in states where huge natural advantages have masked their dysfunctional governments. California, Illinois and New York all enjoy grand cities whose economic dynamism has shielded their states from a generation of fiscal folly. This will end, most likely in 2014.

Our nation will need smart, thoughtful and steady leadership through this crisis. I pray we get it.

Michael J. Hicks is director of the Center for Business and Economic Research and associate professor of economics at Ball State University.