State and city government budget woes and municipal bond risks

Excerpts from a column at the 60 Minutes page of CBS News:

By now, just about everyone in the country is aware of the federal deficit problem, but you should know that there is another financial crisis looming involving state and local governments...

The states have been getting by on billions of dollars in federal stimulus funds, but the day of reckoning is at hand. The debt crisis is already making Wall Street nervous, and some believe that it could derail the recovery, cost a million public employees their jobs and require another big bailout package that no one in Washington wants to talk about...

California, which faces a $19 billion budget deficit next year, has a credit rating approaching junk status... Arizona is so desperate it sold off the state capitol, Supreme Court building and legislative chambers to a group of investors and now leases the buildings from their new owner...

And nowhere has the reckoning been as bad as it is in Illinois, a state that spends twice much as it collects in taxes and is unable to pay its bills... "It's fair to say that there are tens of thousands if not hundreds of thousands of people waiting to be paid by the state," Hynes said.  Asked how these people are getting by considering they're not getting paid by the state, Hynes said, "Well, that's the tragedy. People borrow money. They borrow in order to get by until the state pays them. They're subsidizing the state...

Not all of the problems that Illinois and other states are facing right now can be traced to the recession. But the precipitous drop in tax revenues did expose decades of financial irresponsibility, reckless spending, unrealistic benefit packages for public employees, and the use of political gimmicks to cover up hidden deficits. It's forcing state governors and the public to confront some harsh realities...

Long term, the situation is much, much worse.

"Okay. Let's talk about the pension obligations. Forty-six billion unfunded liability for pensions? Sixty-six billion unfunded for healthcare liability?" ... I think the general public thinks, 'I can't believe anybody gets a pension anymore. I've got a 401(k). It got killed in the stock market. I don't know what I'm gonna do for my retirement. I can't believe people get a pension anymore.'

Governors of cash-strapped states are beginning to cajole or bully public employee unions into making concessions on what are considered to be gold-plated retirement and health care packages, which are now collectively underfunded to the tune of $1 trillion...

"There's not a doubt in my mind that you will see a spate of municipal bond defaults," Whitney predicted.

Asked how many is a "spate," Whitney said, "You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars' worth of defaults."

No one is talking about it now, but the big test will come this spring. That's when $160 billion in federal stimulus money, that has helped states and local governments limp through the great recession, will run out.

The states are going to need some more cash and will almost certainly ask for another bailout. Only this time there are no guarantees that Washington will ride to the rescue.

The full report is at the link, which I would consider interesting reading for any of you who have investments in municipal bonds or related bond funds - especially if those bond funds specialize in single-state obligations.

n.b. - the Whitney cited in this post is Meredith Whitney, a banking analyst who contributes to CNBC, Fox Business and Bloomberg News.  Here is her Wikipedia biographic sketch.  She is also cited (though perhaps not the source of the data) in this Yahoo Finance column about 16 U.S. cities that could face bankruptcy this year.

Perhaps relevant is a Business Insider column which counters Whitney's claims by noting that the servicing of municipal debt is just a small part of a state's budget, so default on such obligations would not be logical -

“The tax- supported debt of an average state is equal to just 3 percent - 4 percent of personal income, and local debt roughly 3 percent - 5 percent of property value. Debt service is generally less than 10 percent of a state or local government’s budget, and in many cases much less.”

Addendum: Another relevant article on the subject is this one at Slate.