Feds might bail out U.S. cities and states

October 4, 2010
Fed

President Ford refused to help New York in 1975, a rejection immortalized as “drop dead.” Historically, the federal government hasn’t bailed out U.S. states and cities facing default. But the EU’s rescue of Greece and the exceptional depth of the recent recession just might change that. Two possible structures for bailouts are budget-avoiding federal guarantees and regulation-bending Federal Reserve bond purchases. Either way, politics may make rescues hard to resist.

Any such action would create huge controversy over constitutional principles of state sovereignty and responsibility. It would also create a potentially hazardous precedent. But that doesn’t make it impossible.

Sure, major direct transfers of cash to states or municipalities, beyond those in the 2009 stimulus package, would worsen federal finances and are thus unlikely. But federal guarantees of local debts would not immediately increase federal budget shortfalls. In fact, limited guarantees for non-federal infrastructure projects were considered as part of last year’s stimulus. A narrowly-defined guarantee program that extended to all states, but mostly helped a few, might avoid the political problems of directly bailing out just one state.

An alternative mechanism could be an extension of the Fed’s asset purchases to include state and municipal bonds. Currently the central bank does not have the power to do this for maturities of more than six months. But an approving Congress could remove that hurdle at a stroke, at least temporarily. That would distance the problem further from the federal budget, burying the risk in the Fed’s balance sheet — though of course it would amount to another form of money-printing, as is the case with the Fed’s existing programs to buy Treasuries and mortgage bonds.

In the end, whether decades of history are overturned may depend on the breadth of state and local financial problems. A guarantee or Fed purchase program to tackle a widespread danger of default could garner political support. Conversely, if default appeared confined to one large entity such as California — as with New York in 1975 — the politics would probably prevent any rescue. If troubled state and municipal governments are hoping they and their bond investors will get federal help, there is probably safety in numbers.

Comments

The States financial problems are the result of over spending on public employees, social spending and bloated bureaucracies. The only cure for the problem is spending cuts. Federal subsidies will only postpone the inevitable and make every citizen responsible for paying for the irresponsible largess of others. This financial crisis is the opportunity that government at every level should be using to negotiate lower public employee salaries and benefits, and review all other spending. The spending path of the states and federal government are unsustainable, the sooner we balance spending to revenue the better off we will all be.

Posted by Daveri | Report as abusive
 

More like states like Texas getting stuck doing the bailing while states like California donate bucket loads to the Democrats

Posted by Laslavic | Report as abusive
 

Quantatative easing never stopped and never will unitl everything and anything is bailed out.This is old news.

Posted by BRION | Report as abusive
 

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