More Bailouts: Are Individual States Next?

As the credit markets unravel, states across the U.S. are faced with mounting financial challenges. Soon, taxpayers may be asked to ante up emergency funds for state bailout programs. California has already said that it may need $7 billion to tide it over until spring.

Within days of the passage of the controversial $700 billion rescue plan, California Governor Arnold Schwarzenegger said that problems in the credit markets were making it hard for his state to borrow to pay its bills. He put the Treasury on notice:  In a letter, he warned that the federal government will be asked for a state bailout if the Golden State can't get the loans it needs.

California turns to pension funds

The authority to provide a state bailout was included in the $700 billion package, but taxpayer money to shore up state treasuries may be in short supply as cash flows out of Washington with remarkable haste. If California needs help and doesn't get it, pensioners will likely bear the brunt of the problem. One stopgap solution already being discussed is to have the California Public Employees' Retirement System and the State Teachers' Retirement System buy some of California's debt, or act as a kind of co-signer on loans to boost the state's creditworthiness.

State of the states

House Financial Services Committee Chairman Barney Frank is critical of a state bailout idea like the one proposed by Schwarzenegger, because he fears it will lead to a domino effect. The Federal Reserve has already been asked if it's ready to lend to Massachusetts, because the Bay State is having trouble finding any investors for its own short-term debt. Since investors are afraid to buy state or municipal bonds, many state governments are running out of options and cash to fund daily operations and make payroll.

Many states enjoyed high real estate values a few years ago, and those translated into much higher taxes. But the housing bubble burst, wiping out property taxes tied to those inflated values, and leaving states with less money at a time when citizens and agencies require more financial assistance.  California and Massachusetts are struggling, because they rely heavily on property taxes as a main source of revenue.

Unemployment bailout

Unemployment benefits present another problem. In Michigan, unemployment is higher than 8 percent, and the state has been borrowing money from the federal government's unemployment trust fund to help make its unemployment benefit payments. In the coming months, the demand for unemployment benefits will put pressure on all states across the country, and nearly a dozen could be threatened by unemployment fund insolvency next year.  They may have to look to the federal government for state bailout assistance.

If the credit markets open up again and resume business as usual, all of these state bailout contingencies can be avoided. But such an opening needs to happen fast, because state governments may soon be running on empty.