I’m Formally Declaring a Fiscal State of Emergency…

by Robert Williams, Publisher
Thursday, March 4, 2010: Issue #1209

“Three years of record tax increases coupled with an economy on the mend have lifted the financial fortunes of all but six states.”

That’s an excerpt from an Associated Press article that ran on January 28, 1984.

Back then, the United States was emerging from the oil shortage-induced recession of the late 1970s, caused by the new regime in Iran. And U.S. states were leading the way back to prosperity, with only six of them running fiscal deficits. Twenty-seven states had budget surpluses!

Regrettably, that’s not the case today. If anything, states are further thwarting any meaningful recovery from taking hold. The sobering statistics tell the tale…

The Land of the Free… And the Home of Debt-Laden States

At the last tally, 44 states face budget shortfalls.

California’s plight is well documented. Already sporting a deficit in the billions, it expects to spend nearly 50% more than it will generate in revenue this fiscal year. Scary.

Nearly as dire are the situations in Arizona and Illinois, where budget gaps are above 40% of general fund spending. (Arizona even has its state office buildings on the market, with hopes of raising $700 million in cash. Talk about desperate measures.)

It doesn’t look good in Alaska, Nevada, New Jersey and New York, either. Each state faces spending gaps of at least 30%.

Softening tax revenue is the main culprit here. Roughly 30 states raised taxes in their most recently completed fiscal year, yet collections over the first three quarters of 2009 (which represents the latest data) plummeted to their worst levels in 46 years.

How’s that math work? It doesn’t. Here’s why…

No Jobs… No Revenue… But a Boatload of Bonds

The United States has lost 8.4 million jobs since the recession began – the deepest cut since the Great Depression.

With 10% of the workforce sitting at home – the first time that’s happened in a quarter of a century – no matter how high you hike tax rates, tax revenue has nowhere to go but down. Dramatically.

As CNN reports, state and local governments have already cut 132,000 jobs in an effort to save their budgets. And while billions in federal stimulus money provided additional relief, those funds will slow to a trickle by the middle of this year. (I can almost hear the local legislators’ cries for help.)

Now here’s where investors need to really take notice…

To make up for the enormous shortfalls, local and state governments have resorted to issuing gobs of bonds. Analysts expect another $400 billion worth to be pushed forth this year.

And presently, there’s little fear of default. Which is crazy.

Given the already sick financial state of the issuers, it’s only a matter of time before we begin seeing defaults. Bank on it.

So what’s the answer?

Want Muni Bonds? Head to These 10 States…

If you insist on tapping the muni market for yields, I can’t stress enough that you stick with bonds from states with the highest rating (usually AAA-rated by Standard & Poor’s, Moody’s, or Fitch).

Specifically, that means bonds from Delaware, Georgia, Indiana, Iowa, Maryland, Missouri, North Carolina, North Dakota, Utah and Virginia.

And do it for the foreseeable future, because a solution to this fiscal calamity is no easy matter.

It’s Time to Bring the Gavel Down on Dangerous State Bidding Wars

The ensuing economic recovery is the best elixir. But requiring states to balance their budgets, without exception, would go a long way to help matters. Many states have such restrictions written into their constitutions, but aren’t upholding them.

Equally as urgent would be to put an end to the bidding wars between states in order to woo big business. This practice is a fool’s game, which often just adds to the deficit.

North Carolina is the poster child for this movement. It’s used customized incentive packages to convince tech giants Google (Nasdaq: GOOG) and Apple (Nasdaq: AAPL) to collectively spend $1.6 billion to build new data centers in the state.

However, the numbers suggest that actually recouping such colossal incentives is a shaky venture at best.

In fact, a prior deal of massive proportion has already gone bust. Last fall, Dell (Nasdaq: DELL) announced that it was closing a computer manufacturing plant in Winston-Salem, NC. It collected $280 million in incentives as part of the 2004 deal.

If this trend continues, states are doomed. And if that worries you as much as it does me, make sure you discourage your local legislators from heading down the same slippery slope.

Ahead of the tape,

Robert Williams

Editor’s Note: Despite the financial problems plaguing many American states, your own finances need not suffer the same fate. The Oxford Club’s flagship newsletter – the Communiqué – has five separate portfolios, each with different aims and tailored to investors’ individual goals.

The track record speaks for itself, leading the independent Hulbert Financial Digest to rank the Communiqué fifth in the United States for risk-adjusted returns over the past 10 years. Check it out right here.