The States Line Up For Their Bailout

I’ve written about this several times and certainly others have as well, but it looks as if some sort of bailout(s) of state and local governments is about to take shape. The whole idea has been kicking around since the early TARP days but it’s picking up speed, so now’s a good time to take stock of what is going on.

The NYT has a good summary:

State and local governments are asking Washington to give them something that banks are trying to get rid of: federal bailout money.

California is asking that money from the Treasury’s TARP, theTroubled Asset Relief Program, be used to help back more than $13 billion in short-term borrowings. Members of Congress and several municipalities want bailout money to be used to cover more than $1 billion in losses from investments by municipalities in debt issued byLehman Brothers, the investment bank that went bust.

And Representative Barney Frank, chairman of the House Financial Services Committee, is drafting legislation that would have theFederal Reserve, and potentially the Treasury’s bailout money as well, stand behind floating-rate municipal bonds — a $400 billion market that provides short-term financing to municipalities, but which has been largely frozen in the current credit crisis.

Another measure drafted by Mr. Frank, Democrat of Massachusetts, would create a public finance office within the Treasury Department to reinsure $50 billion in municipal bonds. This proposal comes as downgrades of municipal bond insurance companies have made it more difficult and costly for state and local governments to issue bonds.

Whew, that’s a boatload of bailout. Of course, California which seems to be serially on the doorstep of insolvency is the lead dog on this whole move. It’s dysfunctional system of governance finally broke down last week when the citizens of the Golden State refused to approve any measures that would address the financial crisis it is facing. Therefore, having failed to clean up the mess they created they are turning to the federal government and by implication the other 49 states to clean it up for them.

The fact that California is leading the way pretty much assures the passage of some type of legislation. You can bet the Democrats are not going to play hardball with a state that has 55 electoral votes and the Republicans probably harbor some delusions about playing along in the hopes that someday they might swing to them. That’s the kind of leverage that every lobbyist in D.C. would kill for.

To be fair, it probably makes some sense to put together some facilities to grease the credit markets. The variable rate demand note market was an important short-term source of funds for government borrowers and it’s sealed shut. Opening it up with some federal backstop is reasonable and done right we might be able to get out of the business fairly quickly.

On the other hand, assisting states and municipalities that have structural deficits on their hands for which they have no exit plan is insane. If the entity can’t show a strategy for either increasing revenues or decreasing expenditures in order to reach a balanced budget then fostering borrowing makes no sense whatsoever. An economic recovery that restores the status quo ante does not, by the way, represent a plan.

The Times article did provide a little bit of comic relief (if you happen to have a very dark sense of humor, that is).

Also clamoring for help is a group of municipalities that purchased Lehman debt, which is now nearly worthless. Legislation authorizing the use of relief money to make these purchases was introduced by two California Democratic representatives, Jackie Speier and Anna Eshoo. If approved, this would be more like a bailout than a guarantee, because the federal government would be paying face value for debt that otherwise has little value.

The price tag on that proposal is around $1.6 billion. The argument promoted by the two congresswomen is that the Treasury and Fed allowed Lehman to fail, causing governmental bodies to lose money. 

That’s what passes for logic in Washington these days. I guess by extension that the government is now duty bound to make good on the debt of any failed private enterprise (Chrysler? GM?). So far this proposal seems not to be gaining traction. That probably means it gets slipped into some bill on page one thousand in the dark of night.

As I said all of this is heating up and something is going to come to pass. The implications not just for the budget but for the entire structure of the Republic are immense. I think it was Megan McArdle who ended a post on the same subject by saying “Farewell Federalism.”

more: here (Warren Buffett’s Thoughts On Municipal Bond Guarantees)

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