Live-Blogging: The Hearings on the State Debt Crisis

Two minutes! That's how long it took for Meredith Whitney to be mentioned in the hearing. "This is not about one analyst," said Rep. Patrick McHenry of North Carolina, the chairman of the House committee overseeing TARP and financial bailouts. (Whitney declined an invitation to give testimony.)

The GOP hewing to the talking points. Rep. McHenry ends his statement by calling for an end to "reckless spending" in the states and in Washington, and "unsustainable bailouts."

Rep. Mike Quigley from Illinois laments the wobbly status of his state's finances. “Illinois has to reform its pension system, but it also has to reform it’s entire way of doing business," he said.

First witness coming up: Nicole Gelinas, a fellow at the conservative think tank, the Manhattan Institute for Policy Research.

Muni debt is a hot topic in Washington and on Wall Street, but this isn't exactly a standing-room-only hearing room. I'm pretty sure one guy in the gallery -- seated behind witness Gelinas -- is sleeping.

Gelinas says bankruptcy is unlikely to help states solve their fiscal problems. (Some Congressional officials reportedly are mulling changes to federal law to allow U.S. states to file for bankruptcy protection in order to shed debts and future obligations such as public-employee pensions.)

Ooh, snap! Next witness, UPenn law professor David Skeel, takes the microphone. "I’m tempted to say, everything that Nicole just said: Not.” Skeel believes Congress - "y'all," he clarifies --should change federal rules to allow states to file for bankruptcy.

Skeel crafts a somewhat tortured metaphor: "Some have argued that a bankruptcy option is not necessary, because nearly all of the states will be able to muddle their way through their fiscal predicament. This is like saying there’s no need for a fire department because most homeowners never have fires in their houses and if one starts they can probably stop it in time. This is true, but we still need fire departments for the rare case where a fire burns out of control.

Skeel says bankruptcy for states, as a last resort, will allow states to restructure troublesome obligations, like public-employee contracts and benefits and bond contracts.

Next up: Eileen Norcross, a research fellow at the Social Change Project at George Mason University

Norcross: pension reform now! State governments are cheating by assuming for unrealistic investment returns for accounting purposes.

Also, folks, you can catch the muni debt hearing live from Washington: http://oversight.house.gov/index.php

Nothing to worry about, says witness Iris Lav of the Center on Budget and Policy Priorities. States are doing the painful process of hacking away at their debt on their own. This is a cyclical problem, she said.

Here's an interesting data point from Ms. Lav:  historical default rates have been at one-third of one percent since the 1970s.

Rep. Frank Guinta of N.H. asks Lav: isn’t this a crisis? How would you define as a crisis, if what we’re seeing from the states isn’t a crisis? “States are finding ways to close their cyclical deficits, Lave said.

Illinois borrowed money to pay its pension obligations, which “is very bad practice,” scolds witness Lav. But mostly, she said states aren’t borrowing money to pay for ongoing operating expenses, just for infrastructure.

Several witnesses have talked about the spiraling costs of health care and Medicaid as one of the biggest headaches for cash strapped states.

Interesting that Democrats tend to be coming down hard to squash this bankrutpcy idea. Rep. Cummings is the latest here, quoting from the governor's association saying stat bankruptcy is not necessary.

Rep. Elijah Cummings asks if it would be helpful to allow states to declare bankruptcy. Let’s take a wild guess. Two of the witnesses will say no. Two of the witnesses will say yes.

Would cutting the federal budget hurt the states fiscal health? Ms. Lav responds yes.

Cummings is asking whether the pension problems are mostly due to the market losses during the financial crisis and the situation is improving with the rallying market.

Lav says "the vast majority of states" will be fine. What she does't mention are the worst funded plans, which will likely not recover no matter how much of a blockbuster stock market rally occurs.

Charts! Rep. McHenry breaks 'em out. He's hitting on the spending levels of state and local governments.

Norcross cites economists' estimates, which have shown the unfunded liabilities faced by state and local government pensions might be as high as $3.5 trillion.

Nicole Gelinas: It's not that we don't understand the magnitude of pension underfunding. It is getting state officials to make changes to deal with the problem

She's on the right track. It's not a secret that Illinois' pension plan is in trouble, for example. The issue is whether Illinois can make the tough decisions to deal with the underfunding like raising taxes or cutting benefits.

Aha! The contagion question finally comes up. Rep. Quigley asks, ok, there are maybe 8 to 10 states that are really stressed. What happens to the healthier states and the bond market if they swirl into the toilet?

 

 

 

Meredith Whitney! First time her name was actually mentioned.

Michael won't brag, but I'll do it for him. Read his Page One story. Lots of light, rather than heat, on the muni debt problem.  http://online.wsj.com/article/SB10001424052748703960804576119870629891478.html

Lav: we are not going to have a major default wave. Maybe some sewer districts default.

Ms. Lav: Only one state defaulted during the Great Depression. Which state? Arkansas.

On the contagion question, Gelinas raises an interesting issue. If banks start to worry that the value of muni debt securities has declined, they may be less willing to extend capital elsewhere. It won't be a crisis or panic on the scale of Sept. 2008, but it might make economic recovery more difficult.

Gelinas: She says if there is any question where states allowed to declare bankruptcy that could upend the muni bond market.

The one issue she said that could create contagion is muni bond losses at banks which could crimp lending to consumers.

The only thing is that the banks' exposure to muni-bonds is pretty limited -- about 1.3% of total assets, according to the FDIC. Mortgage security holdings totaled 10% of assets in 2007.

Ok, Michael: What happens if a sewer district defaults on its debt? The repo man shows up to haul away sludge?

One of the panel members, Rep. Maloney, is asking how can you say pensions are the problem if, on average, they are spending 3.8% of their general revenue on pensions.

Well, one reason is that many states and cities haven't been spending this amount to make contributions each year, leaving a big hole.

 

Shira, good question. The collateral of the sewer district is not the waste water. It is the predictable revenue that these districts collect each year. Check out WSJ's Jeannette Neumann's piece this morning on the bankruptcy case involving the California city of Vallejo. The bonds that have dedicated revenue sources -- such as sewer related bonds -- tended to have high recovery rates in this bankruptcy case,

Jim Cooper of Tennessee asks to put into the record an opinion piece from Jeb Bush and Newt Gingrich titled, “Better Off Bankrupt.” Read it here.

Thanks, Michael! And read HERE Jeannette's story this morning about Vallejo, Calif.

Gingrich is getting a lot attention for this bankrutpcy idea.  Interestingly, the idea has not been proposed as actual legislation, which has led some critics to allege it is a hollow threat aimed at municipal worker unions.

The threat, in esseence, is give in on contract negotiation or else get your pension benefits cut in bankruptcy.

Corkery's Page One story gets name checked by Rep. McHenry.

By the way, here's what the National Governors Association has said about the possibility of allowing states to file for bankruptcy: “The nation’s governors strongly oppose federal proposals to provide states with bankruptcy protection.” Read the statement HERE

Michael, Ms. Lav made an interesting point about the difference in California's borrowing and Illinois's borrowing. What are your thoughts on difference between the two state fiscal situation?

Rep. Quigley says we are not going to mention whitney by name but the question still stands: how many defaults are there going to be?

Lav: No major large city or county will default. But we will see some more control boards where the states take over localities

There’s a discussion about what “default” means in terms of state and local debt. This is has come up with Meredith Whitney’s now infamous prediction that the U.S. might see 50 to 100 “defaults.” Does that mean a state or local government skips the obligation to make interest payments, or does it mean some kind of technical default, which is much less serious?

On control boards, Nassau County -- a fairly wealthy enclave in New York's Long Island -- had its finances seized by the state recently. The county is suing, saying the move was unconstitutional.

Steve, It's a big difference. Illinois is in much worse shape by some measures.  It's borrowing long term debt to make current payments to vendors and pension system.  California borrowing is to cover seasonal cash flow shortfalls, not structural problems. That is not say California doesn't have a large budget deficit.

Rep. Cooper: Individual investors need more information and disclosure about the state of local finances. There needs to be more transparency.

No one on the panel disagrees

One point on the fiscal health of Illinois and California, spreads on Illinois 10-year general obligation bonds has risen 110 basis points in the past year. The spread on California's has fallen 21 basis points in past year.

On the issue of more information and transparency for individual investors (who own two-thirds of U.S. municipal bonds), Gelinas and Lav says muni bonds aren’t like junky subprime securities, which people inadvertently ended up owning in their investment portfolios. There aren't likely to be "bad apple" bond securities in individual mutual funds or money market funds, they said.

Rep. Walsh of Illinois:  My state is a mess

Rep. Walsh of Illinois admits his state “is a mess.” Points for honesty. In fact, several of the panelists today are from states with wobbly public finances: New York, Illinois, North Carolina.

Mr. Walsh wants the panels 20 second solution to the problem facing the sstates.

Norcross's idea to fix the states' fiscal problems: Close battered defined benefit plans, Norcross said. Well, that's a politically tough idea, right?

Not many suprising answers: Norcross: end defined contribution pension plans; Skeel: allow state bankruptcy; Lav: keep on keeping on, no big changes needed.

Blame it on the Fed. That seems to be point Mr. Walsh just made. His point is that by keeping rates low has been good for debtors like states.

Mr. McHenry on public sector employee benefits: Private sector and public sector workers are living in two different economies.

Mr. McHenry asks the question what congress can do to help deal with the crisis. The answer from the panel? Medicaid. Essentially, look to control the rising cost of health care.

Back to healthcare costs. Rep. McHenry asks, what can Congress do to help fix financial problems in the states and local governments? Skeel and Gelinas agree Congress should reform Medicaid. Gelinas suggests changing Medicaid to a block grant from the feds from a matching program that encourages more state spending. Lav said the feds can help by helping keep a lid on healthcare costs across the board.

The hearing is winding down. Thanks for joining us.