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The State Budget Crisis Task Force weighs in

Much as the Simpson-Bowles report aspired to be the foremost guide to reducing the federal deficit, the Volcker-Ravitch report on the state budget crisis that was released yesterday hopes to serve a similar purpose for state government spending. Paul Volcker, the former Fed chairman, and Richard Ravitch, who helped New York City work itself out of bankruptcy, led the State Budget Crisis Task Force, the group that produced this report. The task force also included two former U.S. Treasury Secretaries as members. The bottom line of the report is that there is less money to go around and that states should become better managers of the shrinking economic pie:

The United States Constitution leaves to states the responsibility for most domestic governmental functions: states and their localities largely finance and build public infrastructure, educate our children, maintain public safety, and implement the social safety net. State and local governments spend $2.5 trillion annually and employ over 19 million workers – 15 percent of the national total and 6 times as many workers as the federal government…

…States are grappling with unprecedented fiscal crises. Even before the 2008 financial collapse, many states faced long-term structural problems. Many economists believe that in the aftermath of the crisis, the economy will grow sluggishly for years as it works off the excesses of the credit and real estate bubbles and endures slow employment growth. Tax revenues are recovering slowly and remain well below their pre-crisis trends.

Basically states, once flush with revenues, have overpromised benefits to their retirees, set aside too little in reserves to cover their liabilities, mismanaged their books and sat idly by while their tax base eroded as a result of changes in consumer behavior. The two big issues for state budgets are public pensions and Medicaid, both of which are somewhat out of the states’ control. Although states assume about half the cost of Medicaid, decisions about the program are made at the federal level. States must apply to Washington for an exemption to make changes to their program. Pension benefits are enshrined in contracts and are generally governed by a state’s constitution. Making changes to pensions, outside of bankruptcy, is either impossible or would require constitutional amendments.

The report is a landmark for recognizing that the decades-long expansion of state and local governments must come to an end. Harsh economic conditions have collided with gross structural imbalances, and the report highlights the dimensions of the wreckage.

Troubles in Volcker land?

My post last week about ditching the Volcker Rule and returning to some form of Glass-Steagall got a lot of positive responses. Back then I wrote that the Volcker Rule, which requires regulators to cleave risky trading for a bank’s house account from deposits insured by the FDIC, is immensely complex and that it will never be properly defined or enforced. Several regulators in the past week have agonized publicly over the need to get the rule “right.”

First among them was Fed Chairman Ben Bernanke. In the three minutes of C-Span video above, Bernanke says: “We are going to try and do our best to clarify the distinction between proprietary trading and market making.” It’s clear that even to our top banking regulator, defining Volcker properly is nearly impossible.

SEC Chairman Mary Schapiro had this to say on Volcker, via The Hill:

When asked by Rep. Mario Diaz-Balart (R-Fla.) if regulators would be better off scrapping the proposal and starting over, Schapiro was noncommital.

Forget Volcker — bring back Glass-Steagall

Imagine you are a financial regulator whose agency is underfunded, understaffed and under-trained and that firms under your jurisdiction are likely to pick off your best employees by offering them triple the salary you pay them.

Furthermore, imagine that Congress has written an 800-page law that instructs you to write and enforce new regulations on banks and securities firms to ensure financial stability for the system. The most complex part of this new law, the Volcker Rule, would require you to cooperate with three other agencies to jointly issue a 530-page Proposed Rule that asks 1,300 questions.

Now imagine that in the course of honing this rule, 17,000 comment letters will flow into your agency, the majority of which promote the status quo.

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