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The Politics of the Blue State Bankruptcy

by John Rubino on December 13, 2010 · 45 comments

Today’s Wall Street Journal has a short piece by American Interest editor Walter Russell Mead on how November’s election changed things for California, Illinois, and New York — and for the national parties that have to manage those states’ coming bankruptcy:

Walter Russell Mead on the political consequences of massive state debts

New York, California and Illinois look more like Greece to their bondholders every day. Since the November elections, investors have been dumping their bonds, and hedge funds are betting against them, perhaps realizing that a Republican House is not going to offer generous, condition free bailouts. . . .

Back before the midterms, investors were justified in thinking that Democratic majorities in Congress would rally behind a Democratic president seeking to save the top Democratic states from a financial meltdown. (Much of last year’s “stimulus” actually consisted of emergency cash transfers to strapped states in order to prevent mass layoffs and service cuts.) Now it is much less clear where the states stand and what kind of help will be available. Uncertainty equals risk for bond investors: the White House and the Congress need to plan now to deal with the possible crisis.

A sudden storm in the muni markets will not be fun for Republicans in office. It’s hard to see the Tea Party forgiving legislators who plump for a vast federal bailout of the big blue states . . . [and] it’s hard to see voters forgiving a Congress that doesn’t protect the country from a massive financial breakdown.

But if Republicans will be damned if they do and damned if they don’t, Democrats will just be damned. The prospect of a blue state fiscal crisis is an uncomfortable and threatening one for the GOP; it spells potential catastrophe for the Democrats. The bankruptcy of the big blue states would symbolize the bankruptcy of Democratic party policies to wide swathes of the voting public. Tensions within the Democratic Party would explode: unionized public sector workers would simply not be able to emerge from this kind of crisis without savage layoffs and agonizing cuts in their pay, benefits and pension packages. All the promises (mostly) Democratic politicians have made to them over decades will be exposed for the hollow frauds they were. . . .

The fiscal meltdown of the big blue states, if financial Armageddon actually arrives, will be the biggest domestic crisis for the American people since the Depression, and the biggest crisis for the Democratic Party since the Civil War. . .

Let’s hope a shell shocked White House, a triumphant GOP and an overburdened Federal Reserve are devoting some time to thinking this through in advance. Once a long threatening crisis actually starts, it is much too late to plan.

Some thoughts:

  • California, Illinois, New York and several other states were always headed for functional bankruptcy — the numbers just don’t work and the people in charge aren’t doing anything about it.  The only question was whether their bankruptcy would take the form of muni bond default and mass layoffs, or a federal bailout that created zombie states to go with our zombie banks.
  • To restate Mead’s point: With the Democrats in charge, a bailout was pretty much guaranteed. No way would that party let its biggest electoral strongholds lay off hundreds of thousands of public employees. But a divided government has a more mixed set of incentives. A bunch of blue states defaulting on their bonds and cutting back their public sectors would be painful for Republicans but disastrous for Democrats. So the Republicans might decide it’s worth it.
  • A default would send the financial markets back into chaos (remember that muni bonds make up the “risk free” part of a lot of conservative portfolios). A bailout would shift the crisis from the states to the dollar, maybe causing foreign investors to finally catch on to the Ponzi scheme we’ve been running.
  • And that’s if a few US states go bankrupt more-or-less in isolation. Let them fail at the same time Spain and Portugal are forcing Germany to bail them out, and then who knows? National political considerations might be trumped by global fears, leading to…a headache for anyone trying to follow this thread much further. For now it’s enough to know that state finances will be headline news in the coming year.
  • zeke

    And so the beat goes on. So wise to focus on the Democrat/Republican divide while the taxpayer picks up the tab. There’s an old, old story about a bundle of sticks. Keep em divided is the name of the game. I hear it every day, see it in comments, etc, etc. Comment sections very quickly deteriorate into hateful comments against this party or that or conservative vs liberal, what the hell that even means anymore. Personally it looks like anybody who doesn’t agree with me must be the other. Course it’s mostly Obama now. To me it brings back memories of childhood rivalries. Same mentality, same accusations and same results. Nothing!!

    Only those with zero knowledge (or those out to take advantage of) don’t know this mess has been decades in the making and took both parties plus countless millions of party blind Americans marching to the party tune. I don’t believe salvaging anything out of a mindless party tune is possible. Let’s hope it’s a slide into oblivion and not a cliff.

  • Paul

    @ Zeke

    Don’t fret or worry Sir. All will be well with the world once you crazy Americans vote Sarah Palin into the White House.

    Bi-Partisan Political Nirvana will then reign Supreme.

    • Sidney Poitier

      You Americans? You kidding? If you’re euro, you dont even have a leg to stand on to complain. The entire west is morally, socially, financially bankrupt. Happy? You will die in the resulting chaos.

  • hollow man

    No one will save us. (US). The federal goverement cannot cut 5% much less the needed 35% from mandated spending in addition to all otherspending. 2 parties do not exist. Neither does change.

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  • John

    Unfortunately or fortunately, depending on your point of view, a large percentage of the US population lives in California, Illinois, Michigan, New York, etc. The current path may be unsustainable in these states, but will the feds actually let them fail? They propped up the big banks, why not the big states?

    In the end, maybe they’ll end up like Greece or Ireland. A bailout with strings attached – austerity strings. That makes sense. The alternative doesn’t make much sense at all.

    • bob 1

      Bail them out? With what? Oh you mean more monopoly money. Well that works out well for my gold and silver anyway.

      • John

        I realize it’s Monopoly money, but at present, it still works as a medium of exchange. Anyway, my point wasn’t that this would be a good thing, only that it seems likely to happen, given the alternatives.

  • Ken

    California’s legislative members will never agree upon cuts in there budget as it’s a nanny state as we speak. There is regulation in everything and it will get worse. I think they will survive as long as taxes increase dramatically.
    Which they have and it hasn’t helped…go figure… how deep is it?

  • http://chaosandconspiracy.wordpress.com CompassionateFascist

    California…and USA…are both on a down elevator heading to hell. 2010 Cal election intiatives set up next legislature to pass budget with bare majority, but tax increases require 2/3 vote; meanwhile US Congress is apparently going to flatline revenue while continuing to increase spending on unemployment benneys, entitlements, war….so I’ll continue to invest in tuna fish, silver, and ammunition.

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  • Bruce C.

    Ironically, I just happened to see a portion of “Squawk Box” this morning and they interviewed a spokes person for the S&P rating outfit. That was a major red light for me not only because such a boring and obscure topic was being discussed, but because the main message from the representative was to remind everyone that most municipal bonds are safe.

    “So, what are the chances of one or more states needing a bailout sometime within the next ten years?,” one host asked.

    Her answer was so vague and off-topic that I can’t even repeat it. I swear, I think she was reading from the same script that was used during the sub-prime meltdown.

    Anyway, whether or not the feds bailout/subsidize the states (of any color) won’t change the inevitable. I’m interested to see if the Build America Bond boondoggle is extended (or expanded) for next year, because that is a way to kick the can a little ways more without most people noticing. The Dems will probably insist upon that to extend the current tax rates.

    P.S: J. R., why doesn’t my name and e-mail address automatically show up in the comment fields like they used to? A minor issue, but most other sites save previous poster’s info.

  • boatman


    its the crazy americans who elected obozo-a mirror image of the idiots that led the EU to where its at.

    • Thomas (from EU)

      “The taxpayers are not taking their responsibilities as voters seriously enough. ”

      Half-truth at most. Tell us, who sets the candidates?

      You can’t choose outside of pre-set candidates thus you can choose either one corrupt candidate or the other corrupt candidate: All of them are operating like their owners ( the big money) want, not like voters would want so the responsibility of the voter is practically nil and whole system is thoroughly corrupt: There’s no way voters can change anything.

      Which is the way two big designed it: Shared profit, i.e. cartel, is better than competition.

      Here in EU situation is even worse: Commission can do whatever they want over Parliament (in practise and who cares about theory, just like executive order by the president in US) and no-one in Commission was elected in to their job: Party train going strong and bribery is the norm, not an exception. There being three parties won’t change a thing.

      There have been poor Commissioners when they start their term, but every one of them is a millionaire when the term ends, in just 4 years. Most of course were millionaires when the term begun. Funny, isn’t it? No-one asks where the money came from.

  • http://beforeitsnews.com Concerned Citizen

    My prediction is there will be some form of Federal bailout of the states. It will include new provisions for the bankruptcy of states (there’s no bankruptcy law for states at present) and will come with so many strings attached that these states will end up as Federal protectorates. They will lose any independence they thought they had.

  • r cohn

    The states and municipalities face one of five possibilities.
    1. a full or partial bailout-this of course is filled with all kinds of political problems
    2. a combination of higher taxes and layoffs resulting in less services.
    3. passage of state constitutional amendments allowing a state to lower unionized pension benefits- difficult because of the political influence of the unions.
    4. a sudden resurgence in the economy resulting in sharply higher revenues
    5. bankruptcy for the municipalities and receivership for the states.

    If a bailout does occur ,then it is going to have to be repeated in about 5 more years due to the ticking time bomb of pension and health benefits. Higher income taxes ,which are already at nosebleed levels may very well result in no net gain in revenue as higher income earners leave these states.
    Higher property tax levels which in New Jersey average about 2% of the market value of a house are starting to become confiscatory.At the current rate of increase that level will reach 4% in 12 years.That will mean about 14,000/year on an average house of $350,000.This amount will have one sure result, much lower prices as property taxes start approaching mortgage payments.

  • Goober Confederate Jones

    The first states to go will be blue states. Red states will soon follow. In the hardship and turmoil that attends the collapse of the American economy, people will discover a simple truth. The county was destroyed by Democrats and Republicans. The legacy parties are corrupt beyond redemption. They are at present totally unable to govern. They are zombies like the institutions they defend. They will be abandoned and remembered only by students of history.

    • Rachael

      Astute observation. Republicans and Democrats are supremely to blame. Both are just as bad as the other. There is absolutely no defense of either party. As an earlier poster had noted, when commenting (frequently) I find that as I rail on one party, it is automatically assumed that I am from the ‘other’, and then chastised for it. I am none……and most people still don’t understand what that means. Somehow it is incomprehensible to many that one party isn’t the ‘correct’ choice.

      It is important to note that I consider the Progressives and Democrats to be in the same continuum, just like the Republicans and the Tea Party.

      • U2canbdmj

        False left-Right Paradigm. When a horse owner, owns all the horses in the race he or she is the only one who truly wins. This owner would be the corporations, British empire and free trade, the real central bank owners and not the american people. Any candidate who is CFR, Builderberg and Trilateral has been co-opted by the globalist. All other candidate tend to be marginalized in the media, for example Ron Paul.

      • http://www.nosocialism.com NoSocialism.com

        It’s because of people like you that REAL change NEVER happens. If you were to ACTUALLY LOOK at the makeup of the Tea Party, instead of getting your info from the State Run Media, you would see that this is a party that is GENUINELY INTERESTED in cutting Federal Spending and reigning in the power of the Fed.
        In my book, you’re either part of the problem or you’re part of the solution. The solution is to STOP THE SPENDING. Which is what the Tea Party advocates. At the other end of the spectrum are the “Progressive Liberal Democrats” who have quadrupled Deficit spending EACH YEAR, in the past 2 years.
        You don’t see a BOLD DIFFERENCE There? Are you REALLY taking a look at what the difference is, or simply regurgitating what some pundit on MSNBC has said?

        • Neil MacLeod

          Why don’t you drop the inclination to shout with CAPS and get the real story about US debt for respective presidents and parties from 1945 to the present, here: http://en.wikipedia.org/wiki/National_debt_by_U.S._presidential_terms

        • jim bo

          You did not mention republicans with their military spending?

          • Fried Fish

            Republikrats and THEIR war spending? Hmmm, lets see, who was in charge of the Congress the last two years of Bush/first two years of Obama? Demoblicans, thats who. Wake up, Barney! Both parties are OWNED by the banks. Obama never got us out of the wars, did he, you clown? No! Wake up, Barney.

        • jason

          You mean someone like the fiscally responsible Reagan? Who massively increased the deficit or the Prog Lib Clinton who slashed it? The tea people are a bunch of gun touting, twats, longing for a white apple pie America.

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  • Mark G.

    Congress is the only native criminal class. Some of these folks should be imprisoned for the last financial debacle they put us through. If a Congressman really screws up, he doesn’t get punished, just censured. I don’t expect anything substantive from the next administration. The last contributor was correct, both parties are the problem.

  • Jon T.

    The American people created this mess by cheering the internet bubble and the housing bubble. Millions bathed in the glory of easy money and wealth appearing out of thin air. Almost everyone said it made sense. Almost everyone participated. And now almost everyone is shocked and dismayed as we collectively pay back what was not earned. Corporations profit from cheap labor and wrote regulation and tax law to incentivise stripping America of her manufacturing capacity and sending it overseas. We all went for this scheme because we foolishly believed we could just keep creating wealth out of nothing… flipping houses, etc.. Now every transaction we make siphons off our collective national wealth to some foreign land. But no worry, the engineers of this policy have reaped enormous material wealth. The top 2% capture the spread between what labor here would cost and what they pay for it in China, and then their “profit” is invested offshore in tax havens. There is a giant hole in the economic bucket and it has yet to be even partially plugged. Until it is plugged, the wealth will continue to drain out of this country and the middle class will be reduced to scavengers fighting over a rotten carcass.

  • Jon T.

    Oh yeah, one last thing… NO LABELS, check it out!

  • Lee

    Folks, there will definitly be a Bailout of the States. Only it won’t be done by the “Federal” government. It will be done as quietly as possible by the BANKS that now are sitting on Butt Loads of vitually free US Dollars put on thier Balance sheets by the Fed for Just such an occasion. That way “Federal” help will not be needed–the so called “Free Market” will step in and chalk up another Victory for US [Croney] Capitalism. Congress can’t do anything to stop it either. They can just squawk–and will but to no avail. At some point, the Fed will just “Buy” the paper from the Banks and quietly stick it on its balance sheet of crummy investments once the Poo-Storm passes. So easy a Cave Man Can Do it :-)

    • http://www.nosocialism.com NoSocialism.com

      That’s like saying that they’re going to put a band aid on the Trauma patient just admitted to the hospital who is losing a quart of blood an hour from internal bleeding. Just give him a couple of pints of blood and throw him out the door!
      No, they’re going to HAVE to do MAJOR surgery. They’re currently spending BILLIONS more than what’s coming in and the ONLY WAY to cure that is to cut Millions of state workers from the payrolls and pensions. Tax increases will only expedite the mass transit to Texas currently under way.

  • South Carolina is home of the Jr Mint

    Thank you California and New York for subsidizing South Carolinia as long as you have. Now can we get some fries with that burger?

  • Fred Simpson

    Bailing out California, NY, NJ, Illinois, Michigan etc.. will bankrupt the entire US. Where is President Gerald Ford when you need him ? Even Ireland and Greece got extremely harsh terms under an IMF instructed bailout. And this only occurred to prevent the world seeing the scale of money printing carried out by the ECB in holding up the Spanish banking system.

    What about the concept of moral hazard. You vote continually for the same inept political dynasties like the Kennedys and the Daleys – and you end up with your City/State becomming bankrupt.

    The taxpayers are not taking their responsibilities as voters seriously enough.

    Anyway the most telling point of all for me comes from Walter “John” Williams. I would also add a twist from the Scottish economist Hendry.

    The bubble bursting caused massive deleveraging and deleveraging causes deflation. To deal with this, and prevent the people finding out, Bernanke and pals print money – fighting deflation with inflation. This is a balancing act. We have deflation in some sectors, and inflation in others, and a CPI that is “balanced”.

    This will continue and the balance could see-saw either end. But be prepared for wild swings to one side or the other. And make sure you can profit from this – because the game is rigged to sucker you. And that profit will be needed to preserve you through this !!!

  • Steven Molina

    The American dollar is an invisible currency that soon will hold nothing to the means of the rest of the world. We need to exchange our ” Money ” for gold or silver, or other non Fiat money:
    “Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith.


  • http://www.nosocialism.com NoSocialism.com

    Eventually, we will go the way of Great Britain, their currency was once a Reserve currency, but no longer. The Eurozone already uses their own “Euro” currency, and since the Euro has begun circulation the dollar has been falling precipitously.
    A bailout of California or NY could shake confidence in the dollar and once China decides it will no longer “PEG” it’s currency to the Dollar, that will signal a MAJOR sign of no confidence and if that happens, the rest of the world may follow suit and demand that either a new world currency be created or “something else” becomes the world’s reserve currency.

    As a side note, since Britain is FINALLY cutting Government spending at all levels, it’s possible they are positioning themselves to “retake” the mantle of Reserve Currency.

    By continuing to print money, we’re effectively exporting our inflation abroad and at some point everyone will demand that it end.
    Most people don’t understand the implications of the U.S. losing it’s status as the World’s reserve currency, but let’s put it this way. If we want to buy say Food, Oil or Clothes or Toys or whatever else we’re importing, the people we’re buying from will want something of value in exchange and dollars won’t cut it, they’ll want to be paid in Gold, Silver or other precious commodities, which means truckers won’t be able to AFFORD to ship food to stores, people will quit jobs because they’re being paid with worthless money, and virtually overnight the economy will come to a grinding halt.
    Everyone thinks, “This won’t happen here, this CAN’T happen here”, but truth is it has happened many times before in history and will happen again. The question is will it happen first in Europe with the collapse of Spain, or will it happen first here with the collapse of California. Either way if by the time it happens, the UK, Chile, Russia and China are the only MAJOR countries left with balanced budgets, they will be the ones to decide what to do and the U.S. Dollar and the Euro will be left in the dust.
    Hmmm, maybe I should start asking my clients to pay me in Chilean dollars or the British Pound Sterling.

    • Bruce C.

      I think the reason so many people think that a currency crisis can’t happen in the US is because “we’ve” been hearing about government debt and government borrowing/money printing and “unsustainable situations” for decades. The basic arguments – the same ones that you’re expressing – have been made for years and yet there are no repercussions. Government spending at all levels have risen every year since WW2. One could easily conclude by now that it really doesn’t matter. US interest rates have decreased every year since the early 80’s. Every one and every country has coveted dollars for as long as I can remember. Have interest rates FINALLY started to rise since early November (when the Fed announced QE II) because of inflation expectations or because “big” investors believe US and global economies have turned the corner and are will now be sustainable and improving, as the mass media reports? The fact that rates have risen in all relevant economies in unison globally would support that claim. Personally, I’m amazed that things have gone this far and yet it provides more circumstantial evidence that the proverbial can can be kicked down the road indefinitely.

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  • Brad Thrasher

    The Economist published an OECD chart that purports to identify tax revenue as a percentage of GDP among its twelve member countries.


    Obviously USA tax rates are low by comparison. It is equally obvious that we are attempting to grow our way out of debt. Tea Party members should be readily familiar with that concept.

  • seed

    Capital is money, capital is commodities. By virtue of it being value, it has acquired the occult ability to add value to itself. It brings forth living offspring, or, at the least, lays golden eggs.
    Karl Marx

  • Keet

    Selections have consequences. The Kalifornia state legislature has been donkey blue for 38 out of the last 40 years. It’s bankruptcy will be no accident.

  • hlowe

    “If Democrats are the big spenders, why do Republican states get the money?”

    “data going back two decades—to stick to Simpson’s crude metaphor—show the milk is mostly coming from Democratic states, and the sucking is being done by Republican states. ”

    “The “red” states up in arms about government spending receive the largest share of it. This is not a new finding, but research by economist Gary Richardson at the University of California-Irvine backs it up. Richardson provides insight into how the paradox came about and what it means for the future.”

    “Alaska, home to Sarah Palin, and where two fiscally conservative Republican candidates for Senate recently mopped up 75 percent of the vote between them, received $1.64 in federal benefits for every $1 the state contributed to the national kitty. Massachusetts, Richardson found last year, received 82 cents for every dollar it paid into the national pool. ”


    Will Red states let Blue states fail?

  • Ridiculus Magnus Rex

    Some ridiculous assertions being made here in a lame attempt to continue partisan spin – Truth is, red states have not been that much better off nor effective at controlling spending – take Texas as an example. Many of the red states are in the hole as well. Consider also that red states generally receive more in federal subsidies, whereas blue states generally pay more in, per capita. Only real difference is that red states are generally less populous, so there is a factor of scale. Firstly, “it’s the economy, stupid”. And eroding business translates into eroding tax base, compounding budget issues.

    From a “blaming the government” perspective, we were told that the threat of “excessive taxation” due to expiration of the Bush tax cuts was holding the private sector down and creating “uncertainty”. Well, that “excessive taxation” and “uncertainty” is now gone, and can no longer be held blame. Meanwhile, private sector has been steadfastly refusing to grow, hire, invest, and have been sitting on a steadily increasing reserve of capital, well in excess of a trillion taken out of the market. Politics is no longer to blame, now, if the market does not do its’ part, then it is them we blame.

  • db

    The best Christmas song from Texas. Merry Chistmas.


  • Bruce C.

    I remember noting during the unfolding of the sub-prime mortgage saga that right at the beginning several expert commentators were propped up in front of cameras on various financial shows and gave long-winded esoteric explanations as to why the problem was contained and controllable. I hear the same thing now about muni bonds. “Every bond issuance is different”, “Bond debt is a relatively small part of municipal budgets,” “ Most bonds are revenue bonds vs general obligation,” etc. etc. In the meantime, most municipalities are running deficits. Period. It all sounds too familiar.

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