Michael Cooper and Mary Williams Walsh
The state of Illinois is still paying off billions in bills that it got from schools and social service providers last year. Arizona recently stopped paying for certain organ transplants for people in its Medicaid program. States are releasing prisoners early, more to cut expenses than to reward good behavior. And Newark, N.J., laid off 13 percent of its police officers last week.
While next year could be even worse, there are bigger, longer-term risks, financial analysts say. Their fear is that even when the economy recovers, the shortfalls will not disappear, because many state and local governments have so much debt -- several trillion dollars' worth, with much of it off the books and largely hidden from view -- that it could overwhelm them in the next few years.
"It seems to me that crying wolf is probably a good thing to do at this point," said Felix Rohatyn, the financier who helped save New York City from bankruptcy in the 1970s.
Some of the same people who warned of the looming subprime crisis two years ago are ringing alarm bells again. Their message: Not just small towns or dying Rust Belt cities, but also large states like Illinois and California are increasingly at risk.
Municipal bankruptcies or defaults have been extremely rare -- no state has defaulted since the Great Depression, and only a handful of cities have declared bankruptcy or are considering doing so. But the finances of some state and local governments are so distressed that some analysts say they are reminded of the run-up to the subprime mortgage meltdown or of the debt crisis hitting nations in Europe.
Analysts fear that at some point -- no one knows when -- investors could balk at lending to the weakest states, setting off a crisis that could spread to the stronger ones, much as the turmoil in Europe has spread from country to country.
Rohatyn warned that while municipal bankruptcies were rare, they appeared increasingly possible. And the imbalances were so large in some places that the federal government would likely have to step in at some point, he said, even if that seems unlikely in the current political climate.
"I don't like to play the scared rabbit, but I just don't see where the end of this is," he added.
As the downturn has ground on, some of the worst-hit cities and states have resorted to fiscal sleight of hand to stay afloat, helping them close yawning budget gaps each year, but often at great future cost.
Few workers with neglected 401(k) retirement accounts would risk taking out second mortgages to invest in stocks, gambling that the investment gains would be enough to build bigger nest eggs and repay the loans.
But that is just what Illinois, which has been failing to make the required annual payments to its pension funds for years, is doing. It borrowed $10 billion in 2003 and used the money to invest in its pension funds. The recession sent their investment returns below their target, but the state must repay the bonds, with interest. The solution? Illinois sold another $3.5 billion worth of pension bonds this year and is planning to borrow another $3.7 billion for its pension funds.
It is the long-term problems of a handful of states, including California, Illinois, New Jersey and New York, that financial analysts worry about most, fearing that their problems might precipitate a crisis that could hurt other states by driving up their borrowing costs.
But it is the short-term budget woes that nearly all states are facing that are preoccupying elected officials.
Illinois is not the only state behind on its bills. Many states, including New York, have delayed payments to vendors and local governments because they had too little cash on hand to make them. California paid vendors with IOUs last year. A handful of other states, worried about their cash flow, delayed paying tax refunds last spring.
Now, just as the downturn has driven up demand for state assistance, many states are cutting back.