In 10 Years, Your State May Well Be in the Same Place Where Puerto Rico is Now

By: John_Mauldin

This is the first time on record that two Category 4 hurricanes have struck the US mainland in the same year.

Worse, Harvey and Irma landed on some of our most valuable and vulnerable coastal areas. So now, besides all the problems, the US economy has to absorb the cleanup and rebuilding costs for large parts of Texas and Florida, as well as our Puerto Rico and US Virgin Islands territories.

Now then, people who live in coastal areas know full well that hurricanes happen. They know the risk, just not which hurricane season might launch a devastating storm in their direction.

Yet, the assumptions of what constitutes adequate preparedness were largely flawed.

This also applies to public pensions.

Both pension plan shortfalls and hurricanes are known risks for which state and local governments must prepare. And in both instances, too much optimism and too little preparation ultimately have devastating results.

Puerto Rico Is a Good Example

The Commonwealth was already in deep debt before Irma blew in—$123 billion worth of it. There’s simply no way the island can repay such a massive debt.

Now Puerto Rico is in a new form of bankruptcy that Congress authorized last year. Court proceedings will probably drag on for years, but the final outcome isn’t in doubt. Creditors will get some scraps—at best perhaps $0.30 on the dollar, my sources say—and then move on.

“That’s just Puerto Rico,” you may say if you’re a US citizen in one of the 50 states. Be very careful. Your state is probably not so much better off. In 10 years, your state may well be in the same place where Puerto Rico is now. I’d say the odds are better than even.

Are your elected leaders doing anything about this huge issue, or even talking about it? Probably not.

As it stands now, states can’t declare bankruptcy in federal courts. Letting them do so would raises thorny constitutional issues. So maybe we’ll have to call it something else, but it’s going to end the same way. Your state's public-sector retirees will not get what they were promised, and they won't take the outcome kindly.

The Most Indebted States Will Be Abandoned

Public sector bankruptcy is vastly different from corporate bankruptcy.

Say a corporation goes bankrupt. A court will take all its assets and decide how to divvy them up. The assets are easy to identify: buildings, land, intellectual property, cash, etc.

Not so in a public bankruptcy. The primary asset of a city, county, or state is future tax revenue from households and businesses within its boundaries. The taxpayers can walk away.

Even without moving, they can bypass sales taxes by shopping elsewhere. If property taxes are too high, they can sell and move. When they take a loss on the sale, the new owner will have established a property value that yields the city far less revenue than it used to receive.

Cities and states don’t have the ability to shed their pension liabilities. They are stuck with them, even as population and property values change.

We may soon see an example of this in Houston.

What about those thousands of flooded homes in and around Houston; how much are they worth? Right now, I’d say their value is zero in many cases. Maybe they will have some value if it’s possible to rebuild, but at the very least they ought to receive a sharp discount from the tax collector this year.

Considering how many destroyed or unliveable properties there are all over South Texas, I suspect cities and counties will lose billions in revenue even as their expenses rise. That’s a small version of what I expect as city and state pension systems all over the US finally face reality.

Here in Dallas I pay about 2.7% in property taxes. When I bought my home over four years ago, I checked our local pension and was told we were 100% funded. I even mentioned in my letter that I was rather surprised. Turns out they lied.

Now, realistic assessments suggest they will have to double the municipal tax rate (yes, I said double) to be able to fund fire and police pension funds. Not a terribly popular thing to do.

At some point, look for taxpayers to desert the most indebted cities and states. Then what? I don’t know. Every solution I can imagine is ugly.

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