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Escalating Financial Crisis Grips States

by Stephen C. Fehr, Staff Writer

A week after President Bush signed a $700 billion bailout plan for Wall Street, the financial crisis has deepened in many state capitals with tight credit markets and new, pessimistic budget figures that pose the biggest threat to states’ fiscal health in 25 years.


Grim-faced state officials, seeing reports from the first three months of the budget year that began July 1 for all but four states, are bracing for further declines in tax revenue because of the housing slump, rising unemployment and a slowdown in consumer spending.

Pennsylvania’s revenue collections fell about 5% below estimates made in July, producing the state’s largest first-quarter shortfall in 30 years. A similar lag in Rhode Island has contributed to a record $67 million deficit with nine months left in the budget year. South Carolina — whacked by high unemployment — pared its revenue estimate by 6% and now faces a $554-million shortfall. Massachusetts officials may have to slash up to $1 billion and have warned local governments to be prepared for cuts in state aid.

Even before this fall’s meltdown on Wall Street, state officials had laid off 7,000 employees and reduced services as they cut billions of dollars in spending to plug growing shortfalls in state budgets. Now, as the financial crisis escalated in the last week, governors are taking more steps.

New Jersey Gov. Jon Corzine (D), a former Wall Street executive, said he would address the emergency in a joint session of the Legislature on Oct. 16. California Gov. Arnold Schwarzenegger (R) said he may call a special session after the first-quarter revenue report showed a $1.1 billion-gap. On Wednesday (Oct. 8), Arizona Gov. Janet Napolitano (D) froze state contracts larger than $50,000. A day later (Oct. 9), Virginia Gov. Tim Kaine (D) cut his own pay, laid off 570 employees and dipped into reserves to cope with a two-year, $2.5 billion-shortfall.

West Virginia Gov. Joe Manchin (D) is even considering the unusual step of suing Wall Street firms such as American International Group Inc. to recoup losses in its investments such as the state employee pension fund, a problem shared by many states.

“The bottom line is that states are facing a very difficult fiscal outlook over the next two to three years,” Raymond C. Scheppach, executive director of the National Governors Association, said in a new commentary1 for “This economic downturn will likely be longer and more severe than any states have experienced since the downturn of 1982-1983.”

The financial turmoil has even seeped into the Nov. 4 state elections. Allen Alley, chairman of the board of a Portland semiconductor company and a Republican candidate for Oregon state treasurer, claims in a TV ad that a $6 billion-loss in the state employee pension fund is proof that Oregon needs a treasurer with a business background. His opponent, state Sen. Ben Westlund (D), has accused Alley of campaigning on fear. Treasurer’s races usually are tame, relatively obscure contests.

State officials had hoped Congress’s economic rescue would loosen credit markets so they could start borrowing money again at reasonable rates. But the traditional buyers of state debt, including the money-market mutual fund industry, are playing it conservative and holding onto their cash. What money there is to lend generally is being offered at prohibitively high interest rates; Oregon had been borrowing money at 1.75% earlier this year but is holding off now that the rate is over 9%.

“This all boils down to lack of confidence in the market and where it is heading,” said Sujit M. CanagaRetna, senior fiscal analyst for the Council of State Governments. “The extent of the unknown is still significant. Only now are states realizing the full impact of the credit markets freezing up.”

Many state and local governments sell short-term notes or borrow money during periods when their funds are low and they are waiting for tax revenue to come in. The money is spent on such day-to-day operations as paying state employees. Governments also sell long-term bonds to finance expensive building projects on college campuses and on state roads and bridges.

New Mexico officials, like many others in state and local governments, have twice postponed the sale of $500 million of what are known as “tax anticipation notes” needed to help with cash flow.

One sign of a possible thaw in the credit freeze came Wednesday (Oct. 8) when Massachusetts officials announced they had sold $750 million in short-term notes at a favorable 2.2% interest rate after twice postponing the sale. Ohio and Kentucky also sold long-term bonds for transportation and university projects, not for day-to-day operations.

“Especially at this time, we are pleased that these funds will allow for positive benefits to Ohio’s economy to start almost immediately,” Mike Miller, director of the Ohio Public Works Commission, said in a statement.

On Thursday (Oct. 9) Schwarzenegger told U.S. Treasury Secretary Henry Paulson that California may not need to borrow $7 billion from the federal government as he suggested last week because the state is hopeful it can obtain short-term financing elsewhere.

Most states have enough cash on hand to meet their needs for several weeks. But if the credit market doesn’t thaw soon, officials say, some states will run out before tax collections pour in this spring. Massachusetts treasurer Timothy Cahill said, for example, that the $750 million borrowing will cover the state only through November.

The Federal Reserve announced Oct. 7 that it would create a program to buy commercial paper from eligible businesses, one way companies can borrow money for short periods. Some state officials say they may ask the federal government to include states in the program. Officials also are discussing ways the federal government could guarantee the sale of states’ short-term bonds despite Internal Revenue Service restrictions against federal guarantees of tax-exempt financial instruments.

In addition to the problem of short-term borrowing, states could be forced to postpone big-ticket projects if they can’t obtain long-term loans. Iowa wants to issue $183 million in bonds in November that among other things would finance expansion of a state prison and construction of a state office building. Oregon is planning bond sales in the coming months for projects to make state universities more energy-efficient and to extend a light rail line in the Portland area. Missouri wants to issue bonds to finance a $700 million program to improve 802 of its worst bridges by 2012.

Not every state depends on bond sales to finance its operations and building programs. And some did quite well in the first three months of the budget year, especially those benefiting from high oil and commodity prices. Montana has a surplus of nearly $1 billion over the next two years, creating a very different policy dilemma there: whether to set up a permanent “rainy day” fund just in case things go bad.

Go to for links to various happenings and officials referred to in this article and also see related stories:

Fiscal report sees ‘great trouble’ brewing for states (10/7/2008)

State jobless funds are running dry (10/7/2008)

State workers face bleak budget picture (10/3/2008)

States act to cushion Wall Street meltdown (9/30/2008)

State jobless benefits reserves low (6/2/2008)

23 states face budget gaps in 2009 (4/25/2008)


1 Scheppach, Raymond C. , “It could get worse before it gets better,” Oct. 10, 2008.

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