California, Illinois Debts Starting to Worry Federal Reserve

If worries about a European “debt contagion” aren’t enough to keep Federal Reserve Chairman Ben Bernanke awake at night, he’s starting to worry about a California and Illinois debt contagion.

During a Senate Banking Committee hearing July 14, Bernanke said those states’ unfunded obligations and unpaid bills concern the Federal Reserve.

“We watch [California and Illinois] very carefully,” said Bernanke. “We also look at exposures of banks and other institutions to those states.”

Nation’s Worst Ratings
California and Illinois have the nation’s worst credit ratings among the 50 states, the result of huge budget deficits, outstanding debts, and unfunded liabilities for retirement benefits for government workers.

“A number of states do need to be thinking about their longer-term sustainability, given the unfunded liabilities they may have in state pensions and in some cases health-care programs,” Bernanke said.

Bernanke was responding to questions from U.S. Sen. Mark Kirk (R-IL), who asked whether federal officials are watching for domestic risks to the financial system as well as overseas risks.

“As Greece has ruined the bond market of Europe, so could Illinois and California ruin the bond market of the United States,” Kirk said.

$273 Billion Combined Shortfall
A recent report from the Illinois-based Institute for Truth in Accounting notes only four states have enough assets on hand to cover their debt and retirement obligations. California has a $163.6 billion shortfall. Illinois is $110.6 billion short, according to the report.

Illinois lawmakers this year—on the last day of the lame-duck session, shortly before new lawmakers would have been sworn in to block the action—raised the state’s personal income tax by 67 percent and the corporate income tax by 46 percent. Kirk said citizens were misled into believing the tax increases would fix the state’s budget problems.

Growing Stack of Unpaid Bills
Instead, State Treasurer Judy Baar-Topinka (R) this summer announced the state had piled up more than $4 billion of unpaid bills and said the total could reach $8 billion by the end of the year despite the sharply higher tax rates.

“It’s the unfunded liability that … increasingly looks like it will cripple the state’s economic future,” Kirk said. “And I’m worried that state leaders are not being clear, concise, and fully transparent on the bleak future that faces Illinois because its leaders will not cut spending.”

In California, Gov. Jerry Brown (D) in June vetoed a budget with a $9.6 billion deficit and worked out an agreement with lawmakers that includes a mix of tax and fee increases and expirations, the elimination of some 400 local redevelopment agencies for a savings of $1.7 billion, and more than $5 billion of higher projected revenues from assumptions of an improving economy.

If revenues do not increase as much as expected, up to $2.8 billion in additional spending cuts could be required.

Steve Stanek (sstanek@heartland.org) is a research fellow at The Heartland Institute and managing editor of Finance, Insurance & Real Estate Policy News.