NCPA - National Center for Policy Analysis

State Bailouts? They've Already Begun

November 5, 2010

The threat posed by the state fiscal crisis in the United States is vastly underestimated and underappreciated, says Meredith Whitney, CEO of Meredith Whitney Advisory Group LLC.

A clear example of this took place in Manhattan last week at the Economist magazine's Buttonwood Conference, where a panel role-played the federal government's response to a near default of the hypothetical state of New Jefferson.  After various deliberations and simulated threats from the Chinese government, the panel reluctantly voted to grant New Jefferson an emergency bailout of $1.5 billion to cover the state's debt payment.

What this panel and so many other investors fail to appreciate is that state bailouts have already begun.

  • Over 20 percent of California's debt issuance during 2009 and over 30 percent of its debt issuance in 2010 to date has been subsidized by the federal government in a program known as Build America Bonds.
  • Under the program, the U.S. Treasury covers 35 percent of the interest paid by the bonds.
  • California is not alone: Over 30 percent of Illinois's debt and over 40 percent of Nevada's debt issued since 2009 has also been subsidized with these bonds.

Beyond debt subsidies, general federal government transfers to states now stand at the highest levels on record.  Today, more than 28 percent of state funding comes from federal government transfers, says Whitney.

These transfers have made states dependent on federal assistance.  

  • New York, for example, spent in excess of 250 percent of its tax receipts over the last decade.
  • The largest 15 states by gross domestic product spent on average over 220 percent of their tax receipts.

At the same time, local governments now rely on state government transfers for 33 percent of their funding.  Thus, when a state finds itself in a financial bind, it has the option of saving itself before saving one of its local municipalities.

Rather than waiting for more federal intervention, states need to make their own hard decisions and not kick the can down the road, says Whitney.

Source: Meredith Whitney, "State Bailouts?  They've Already Begun," November 3, 2010.

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