We’ve been discussing the disastrous state of State Finances for many years, starting in earnest in 2006 with our Death of Pensions Report.  We have highlighted underfunded pensions and underfunded (and almost never-discussed) healthcare benefits, which states call Other Post Employment Benefits (OPEB’s).  Our position was that not only were these items a cause for concern, but that the dual forces of a market meltdown and slower economy would cause the issue to become much, much worse.

And here we are. 

The Pew Center released their latest report last month showing the most recent state of things.  It’s not pretty.  And it gets worse.  The Pew Center’s data is through June 2008.  Yep, pretty much right before everything fell apart. 

Barron’s cover article this weekend is “The $2 trillion Hole,” which outlines where states are today, given an estimate of how things have changed since the ugly, but better than now position of the Pew report. 

I would link to the Barron’s article, but they go under a paid site for content.  The interesting part to me is not the general discussion, as that shouldn’t be news to anyone who reads our work.  What is interesting is the example of Vallejo, CA.  This city gave very generous (over $100,000 per year) pensions to many workers.  As property values soared, so did tax revenue.  But then the music stopped. Property value tanked, tax receipts fell, but the pension obligations remained.  The city cut services to the bone and then some.  Finally, they gave up the ghost and declared municipal bankruptcy. 

The final details of the bankruptcy haven’t been nailed down, but as the very end of the Barron’s article states,

“Though Vallejo is still months away from getting a court decision on whether it can go ahead with its debt-adjustment plan, it has succeeded through contract renegotiations and major layoffs in cutting its employee costs by nearly a quarter. 

But the fallout has been brutal.  Employee health-care benefits have been decimated.  Holders of the city’s municipal bonds are unlikely to get all their money back.  And violent crime rates have shot up dramatically as a result of reductions in its police force from 158 to 104 officers.

The only thing that will be left untouched? The very thing that tipped the California city into Chapter 9 — its $84 billion in future pension obligations.”

I added the emphasis.  This is not over.  This is not the end.  The fact that these obligations were not reduced, no matter how painful that would be, means that the issue will be revisited.  Does the state of California, in its curren fiscal mess, take on the obligation?  How about the US government?  Now multiply that across the country. 

Everyone knows what ails Detroit.  The inexorable decline of America’s auto manufacturing has created a large city with a gaping black hole where its leading industry used to be.  So, there is no real reason to dwell on how Detroit got into its current state.  What is interesting is how the city is attempting to cope with its demise.  Take a look at this AP headline:

“Detroit wants to save itself by shrinking.”

The AP writes,

Detroit, the very symbol of American industrial might for most of the 20th century, is drawing up a radical renewal plan that calls for turning large swaths of this now-blighted, rusted-out city back into the fields and farmland that existed before the automobile. Read the rest of this entry »

The Greek debt crisis is now reaching the levels of the absurd.   There seems to be a growing consensus that Germany will step forward and bail Greece out.  The problem with this?  The idea is WILDLY unpopular in Germany.  In fact, German lawmakers have suggested Greece sell off its island to pay off its debts rather than run to the EU’s more responsible members for help: “Greece Can Sell Islands to Cut Debt.”

Even if Germany wanted to help Greece, it’s not entirely clear that they can.  According to the Financial Times, Germany is
forbidden by a 1993 Constitutional Court decision that stipulated that Germany would be forced to leave the eurozone if the union did not follow the principles of monetary stability.  So, in a nut shell, if Germany bails out Greece to save the euro…Germany will have to leave the euro.

Politicians are masters at circumventing laws and court rulings, of course, and it is entirely possible that Germany may still come to Greece’s rescue.  But for now, the crisis continues, and investors are left to ask “what next?”

Charles Sizemore, CFA

Related posts:

Greek Mythology

Update on Greece

Kelly Evans has a short piece in the “Ahead Of The Tape” section of the WSJ this morning that highlights the lack of inflation.  The article, titled “Inflation Hawks Should Stand Down,” shows a tiny snippet of what we keep pointing out as one of the greatet economic drivers (in a bad way) of the next few years - deflation.

 The main chart shows money supply growth, which of course rose dramatically during the height of the crisis, but has since then fallen back and even dabbled with going negative.  Why?  The great retrenchment in lending.  As we lower the amount of debt outstanding through repayment or modification, it shrinks money supply.  This side of the equation is always left out by those who point to massive inflation being on the horizon.

This is not cause for celebration.  This is a fearful development that we have been forecasting, talking about, and generally shouting from rooftops for over a year.  The great de-leveraging is under way.  It won’t be pretty.

“What is a generation?” asks Ira Wolfe in his new book Geeks, Geezers, and Googlization.  “A generation is a group of people who are programmed by events they share in history while growing up… a common set of memories, expectations, and values based on headlines and heroes, music and mood, parenting style, and education systems.”

I would agree with this definition, and would add that it ties in with the concept of generation gap.  Parents (and sometimes even older siblings) often do not “get” their kids.  They don’t understand their vocabulary.  They don’t understand what motivates them.  And they absolutely, for the life of them, cannot understand why a pieced eyebrow is cool.  (Who am I to criticize…in my childhood, coolness was defined by acid-washed jeans that were tightly rolled around the ankles and permed hair and makeup on male rock stars.  Go figure.)

Mr.  Wolfe’s book is an interesting study on the relationships between the generations in the workplace.  It’s very similar in substance to the generational work done by William Strauss and Neil Howe (Generations, The 4^th Turning, Millennials Rising), but it’s much less academic and, frankly, quite a bit easier to digest.  Corporate executives who find themselves managing a multigenerational workforce should find the book quite valuable, as should anyone struggling to understand the generation gap in their own home, for that matter. Read the rest of this entry »

With March of 2010 upon us, many state legislatures are starting their sessions. Job one will be to figure out how to close the current budget gap.  Job two will be to develop a semblence of a credible budget for 2010-2011 budget year, which begins for most on July 1st. 

With traditional revenue sources dropping, state governments are in a quandry of their own making.  For decades they have gone along the politically easy path of continuing to promise and secure employment contracts for all levels of state workers.  Now that tax receipts ain’t what they used to be, these contracts (including pension benefits, healthcare, etc.) are crippling.  So, what to do?  Play hardball with the unions?  Not so fast. There is another way.

States have raised fees at an extraordinary rate (in the state of FL the tax on cigarettes increased by $1 per pack last year), even though this approach is most difficult on the lowest income earners.  Now states are beginning to take another look at taxing non-profits, pointing out that these organizations get the benefit if services (Fire, Police, Streetlights, etc.) without paying.  While that is true, the point of a non-profit is to provide services in the community that otherwise would not be available or would only be available at an increased cost to users.  Should non-profits pay some sort of tax?  I can’t say that I know the answer, but a piecemeal approach doesn’t strike me as appropriate. 

On another front, expect state legislatures to take another run at taxing internet transactions.  The sales tax lost to internet transactions is staggering, and definitely impacts the bottom line of taxing authorities.  The old argument of “It’s too hard to figure out who should pay what,” doesn’t hold water anymore either, as many retailers who have mulitple places of business in different states have already figured this out. 

My point is that as these legislative seasons get underway, look closely at what gets passed in the name of a balanced budget.  It will be much more about raising revenue than attacking the real problem - spending.  And grab hold of your wallet.  If you don’t, they will.

You have to give the Spanish style points. The country that gave the world the gallant Don Juan and the ridiculous Don Quixote has now introduced the gentleman bill collector, “El Cobredor del Frac,” which translates loosely to “the debt collector in top hat and tails.”

The Christian Science Monitor wrote a hilarious piece on the Cobredor (”Where debt collectors use shame as a tactic“).

Collecting debts in Spain via the court system is a difficult and time-consuming process.  So instead, collectors appeal to a debtors sense of shame:

Last year, for example, the agency had a case of a couple who did not pay the €60,000 ($83,000) bill for their fancy wedding. “The wedding company contacted us, we got a guest list and started phoning up the guests one by one…,” recalls Pablo, “asking them if they had had the lobster or the chicken – and then asking them where to send the bill.” Eventually, the embarrassed bride and groom decided to pay up.

Desperate times call for desperate measures.  And with global deleveraging still continuing to suck liquidity out of the system, don’t be surprised to see more…shall we say, “innovative,” ways for desperate lenders to collect debts.

The Baby Boomers seem bound and determined to prove that they are NOT, in fact, too old to rock ‘n roll: “Marijuana use by seniors goes up as boomers age”

It appears that, with the kids now out of the house, Mom and Dad no longer feel obligated to set an example and can revisit their libertine days of the 1960s and 70.

Perhaps this is exactly what America needs; seniors who are stoned out of their minds and thus pacified.  Hey, it’ll make Social Security and Medicare reform a little easier to take.  If President Obama were smart, he’d make sure to legalize marijuana for seniors BEFORE he cuts their pension and health benefits and raises their taxes.   And if that fails to ease the pain, he might have to start legalizing harder drugs too.

It really brings new meaning to “Stimulus Bill.”

The WSJ reports this morning that lending by FDIC-backed banks fell at an “epic” pace in 2009.  The drop was -7.4%, or just over $500 billion.  In addition, banks wrote down $53 billion in loan value.  Keep in mind that this only lending at FDIC-backed institutions.  This does NOT include other financial institutions like the investment banks.  In the world of Asset-Backed securities, there has been over a $1 trillion in write downs/losses.  These forces are acting as a counter-balance to the the actions of the Federal Reserve - i.e., printing money - and therefore creating a seesaw between slight inflation and slight deflation.  The fight goes on.  Our view is that deflationary pressures will win, and we will all lose. 

While most of the world’s attention is focused on the Greek financial crisis (and with good reason), there is a smaller but still quite serious crisis spreading in the sands of Arabia.

The Financial Times reported this morning that “Debts threaten to engulf Kuwait’s investment industry.”

Most of Kuwait’s multibillion-dollar investment company industry could be wiped out by debt repayments on the finance houses’ leveraged investments made before the recession, senior bankers have warned.

Spurred by cheap credit, abundant liquidity and few other opportunities in the government-dominated economy, Kuwaitis have set up scores of investment houses to bet on international and regional real estate, private equity and stocks…  However, much of the spree was financed by short-term loans, and the financial crisis hit the local investment houses like a tsunami, said one analyst.

Borrowing short term to finance risky and illiquid assets?  Sound familiar?

A blow-up in Kuwait is likely to be more or less contained.  But, as the Financial Times points out, there could be some amount of forced selling that pushes down the values of assets abroad.  This is not a “Lehman moment,” but it is something to keep an eye on lest it spreads to other neighboring markets in the Middle East or to emerging markets in general.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy