Watch out for State Debt Defaults


A little-watched issue that is starting to become a big problem is that of state debt.  States for years have acquiesced to public union demands for more lavish pensions.  For a politician this is an easy sell because he will be long gone before the bills are due.  Sure, you can retire after 20 years and draw a pension as large as your salary or higher.  Sure, you can spike your payout by working triple overtime during your last few years.

One effect of the financial crisis in the reduction in state revenues.  This, combined with the pension burdens which are causing greater and greater outlays of state funds to go to personnel costs, is causing many states to go to the brink of insolvency.  California, Illinois, and Nevada are already in dire straights and would have defaulted or faced serious cuts in services if it weren’t for Federal Assistance under the Build America Bonds program.   Many states are underfunding pension plans and issuing debt to meet daily expenses.

Eventually these states will run out of the ability to issue bonds and/or the requirement to fund public pension plans becomes too great, at which points defaults may become likely.  A federal bail-out may be necessary, but this won’t sit well with states that have been fiscally conservative.  This could be the next big financial crisis.  Be cautious around “safe” municipal bonds.

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