Gillian Tett notes that the “divergence” that has caused such strain in the eurozone, is also in evidence in the United States. By divergence she means the relative economic health of Germany compared to the insolvency of Greece or Ireland. In America, one sees similar divergence in the relative health of, say, Utah, compared to the relatively ill health of, say, Nevada. Ms. Tett writes:
A large component of the rising debt burden in American states is the cost of public pensions. Taken as a whole, this figure looks alarming: Joshua Rauh, an economist at Northwestern University calculates that underfunded liabilities were running at around $3,000bn by the end of 2008.*
But, as Rauh adds: “There is a substantial cross-sectional variation in the health of pension plans.” Some states, such as Illinois, are already in such fiscal straights that they will run out of money to pay pensions as early as 2018, according to Rauh’s calculations (which assume 8 per cent asset returns). Connecticut, New Jersey and Indiana face the crunch in 2019. However, other states hit the wall between then and 2047 – and five states never run out, Rauh suggests.
Until now, economists used to assume that such regional variations would be partly self-correcting, since the US has a Federal government and relatively high degrees of labour mobility – in sharp contrast to Europe. But the pension issue gives a new twist.
For one thing, it is unclear whether US workers are still as mobile as they used to be, because the housing crisis has left millions of people almost trapped in their homes. In some regions of Nevada and California, for example, more than half of all mortgage holders are now blighted by negative equity and cannot sell. But even if workers are still mobile, if migration does occur it could make economic discrepancies worse. “While citizens of states that are particularly hard-hit by the pension crisis might be able to escape to other states, an acceleration of this demographic phenemona would leave a dwindling taxpayer base behind in the states facing the largest liabilities,” says Rauh. Hence the frantic attempts of Detroit, say, to keep its young workers insider the city.
All this has potentially big implications for the future of muni debt. Some observers, such as Rauh think that if the discrepancies keep widening, there will eventually be an increased “likelihood of a federal taxpayer bail-out”. Perhaps so. But this week’s debate in Congress shows just how difficult that could be to implement – if it ever occurs at all. Either way, what is crystal clear is that it is no longer safe to treat muni debt as a quasi homogenous asset class (as many retail investors used to do). As with the eurozone, the prospect of variation – and arbitrage – is rising.
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