The Federal Takeover of State Debt is About to Begin…

Often people focus on the “loud” items and miss the subtle, important events that really change the world. On the positive side, the 401(k) plan has that obscure name because a financial expert basically “invented” it out of a line in the tax code which enabled tax-deferred savings. And Jack Bogle of Vanguard did the same thing with “passive” investing, which reduced fees and for practical purposes has taken over the investing world (along with ETFs).

One very subtle item that is about to occur is the nationalization of state debt (and likely debts of individual cities) by the federal government. At the highest level, states and cities have made promises (mainly pensions) to their employees that are un-payable without raising taxes to extortionate rates. Detroit cracked first but since it was a city and there was some state framework they were able to use bankruptcy, but many more are to follow, including Puerto Rico (right now) and soon thereafter likely the City of Chicago or its teachers’ pensions as well as the state of Illinois.

A very similar event occurred in Europe when the ECB basically put the debts of Greece and Portugal onto the backs of taxpayers in Germany and Holland. The ECB had a moment (several moments, actually) when they could have fundamentally changed how Greece ran their economy, shutting down statist laws and heavy governmental interference in the economy to open up competition and growth, but they blinked and instead just “wired them money in exchange for promises”. The Greeks, of course, haven’t kept their promises, and why should they, given that the ECB continually blinks when the showdown occurs.

The reason that these states and territories like Puerto Rico are in dire straits is because they

1. Spend more money than they make every year,
2. Rely on borrowing to pay for operating expenses,
3. Have giant, unfunded liabilities on top of this that can never be repaid (pensions, medical bills, etc…).

This situation is enabled by a governing class that views funds as an opportunity to redistribute wealth to favored constituents and relies on “fairness” as a bedrock of their planning. The apex of this sort of planning can be seen in crony capitalist states like Brazil, where large enterprises like the National Oil Company (partially on the stock market, partially owned by the state) are used to fund politicians and social programs and are systematically diverted away from their core mission (to make money) until the enterprises are bled almost totally dry. Then, ironically, the state has to bail out the very companies that were supposed to provide for the socialistic wealth in the first place.

The CORE issue is – if you give these sorts of entities money (bailout) without a “root and branch” cleaning of the issues – you will just get more of the same, indefinitely, as their individually painful debts become part of the larger national (or pan-European) debt, which continues the little game of overspending and wasting money on favored political groups for a little longer (maybe a couple years, maybe longer).

The slippery slope – the trigger – is occurring right now in Puerto Rico. That entire economy is corrupt and ridden with subsidies from electricity to taxes to everything else. For Puerto Rico to thrive, it would need to break down barriers to private enterprise, reduce taxes, levies and bureaucracy, and find some way to bring logical industry into their jurisdiction. However, the more likely course is as follows:

1. Point out the current individuals suffering from a lack of funding (the poor, kids in school, the elderly),
2. Note that the debt which was once owned by individuals was bought up by hedge funds for a fraction of its original value – these funds are in a position to fight (legally and politically) for repayment and although they may be termed “vultures” or something else, they really are the last man standing for individuals who lack the means to fight legally for their rights,
3. Use the political system to “promise” reforms that will never be carried out (because why would you if you can use funds to enable the current system to thrive),
4. Talk about the retirees, and “promises” made to them over the years that cannot be paid, and how they can’t go back to the work force and earn more money so that they have to be made whole,
5. Use political or class warfare to point out the groups that run Washington don’t look like the groups that are broke and make it a fairness issue or tied to some century plus grievance.

It is very likely that these tactics will “work” and that the debts of Puerto Rico will be backstopped by the US government. While this technically isn’t a “bailout”, it absolutely is, because Puerto Rico can’t borrow one dollar on their own anymore (who would lend money to someone who says they won’t pay you back?), and we know that without major reform (which won’t happen) Puerto Rico will just continue to bleed money indefinitely (and fall back on fairness arguments and the above listed tactics to ensure that this keeps happening).

Then soon after this subtle bailout (and likely before Puerto Rico fails AGAIN, which will happen again as it will with Detroit), entities of Illinois or the state itself will drive straight through this loophole and federalize their debt, too. The state and entities will make lavish promises about change that will never occur, because this is the lifeblood of the Democratic Party (patronage workers and the public sector) and all of the clout / featherbedding / etc… will continue on indefinitely, without any of the sorts of laws that enable competition.

Watch the headlines… see this occur… it will be seismic in its long-term nature, because it will fundamentally change the nature of the US government, since the debts of the states and cities will become everyone’s debt and we don’t have any “real” tools to govern their behavior or fix the long-term promises that destroy competitiveness and economic growth.

This is the real story, it is happening under our noses, and instead of paying attention we are following these idiotic presidential campaigns of pure vapor.

Cross posted at LITGM

13 thoughts on “The Federal Takeover of State Debt is About to Begin…”

  1. This is what you get you get when people elect liars and criminals to govern them. They hear ‘free stuff’, vote for that, and don’t worry about the consequences, because those same liars and criminals told them there won’t be any. Back that up with endorsements from irresponsible and largely uneducated celebrities and they’re a slam dunk shoe-in for achieving power. The more they become dependent on government, the more socialism they need and want. Rinse and repeat. Anyone who challenges the fairy-tale is a right wing extremist. Fast forward a few years and you have economic collapse.

  2. Great piece, Carl. 100% (to borrow a currently in vogue political expression).

    The perverse incentives for state and local malfeasance increases astronomically when the debt for this shell game can be passed on to the country as a whole, not just future generations in the jurisdictions. Just like the pork from DC the incentive for all jurisdictions is to “get us sum” while the “gettin’ es gud”. Who doesn’t want free stuff like debt transfer to DC?


  3. Unless you actually enumerate what’s going wrong, order it by destructiveness, and poll the legislature on their willingness to make things better law by law, regulation by regulation, things don’t get fixed. We just get the can kicked down the road.

  4. Well.
    So there will be no incentive to “reform” for anybody until there’s nobody left in a “revenue positive” position.
    At which point it’s too late.


  5. “it will be seismic in its long-term nature, because it will fundamentally change the nature of the US government”

    Long term? No. The empire is expressing its final gasp. This will not last long.

    Fundamental change? Not really. Government has always been about showering funds on favored interest groups and plundering the middle class.

    Just another step off the cliff, the inevitable progression toward Revolution.

  6. I think that the acceptance of the debt of sovereign states and cities will start a revolution or coup.
    I will stop any Federal representative who tries to burden citizens with taxation without representation.

    At the point of a bayonet, we will not pay for a corrupt Chicago City council debt or California’s $200,000 a year lifeguard pension. America will end or the losers will declare bankruptcy and restructure their debt.

  7. “As it will be in the future, it was at the birth of Man —
    There are only four things certain since Social Progress began: —
    That the Dog returns to his Vomit and the Sow returns to her Mire,
    And the burnt Fool’s bandaged finger goes wabbling back to the Fire;”

    “And that after this is accomplished, and the brave new world begins
    When all men are paid for existing and no man must pay for his sins,
    As surely as Water will wet us, as surely as Fire will burn,
    The Gods of the Copybook Headings with terror and slaughter return!”

  8. one thing that is for certain, it can’t nor will it continue forever as the collapse of the dollar, and the world financial system, is upon us.
    I would say that we have less than a year. This is planned, as is the debt absorption by the feds.
    A new currency is coming which will not be good news for the world, although the thieving bankers will sell it that way.
    these bankers will never forgive debt, just reassign it on a different way, much like what refinancing does when you are upside down on a car..they make it disappear, although it really doesn’t go anywhere.

  9. Artificial intelligence is no match for natural stupidity. And if you can smile when things go wrong, then you probably have someone in mind to blame.

  10. This sounds like a totalitarian conspiracy toward a one world government. I bet the next thing they will attempt to do is abolish all national borders.Well! I’m sure that mark on your forhead or your right hand will be considered very fasionable too.Complacency has dire consequences as history and prophecy prove.

  11. The debt will be retired eventually, so I am suggesting an outlet:

    Retire T-bonds for a Federal Credit Receipt (FCR) at the Treasury. Rather than bond-holders selling the bonds for USD and spending it, causing inflation, the FCR can be redeemed for assets with the Treasury, Fed, and Congress controlling the terms.

    It allows direction of resources to building the economy and infrastructure.

    SSA turns in 10 bonds to the Treasury for an FCR. That FCR could be redeemed for a Texas Stock Market, with oversight from Fed economists.

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