State budget gaps accompanied by forced austerity measures will act as a huge economic drag in the second half of the year unless Congress plays sugar daddy once again.

Bloomberg reports States of Crisis for 46 Governments Facing Greek-Style Deficits

Californians don’t see much evidence that the worst economic contraction since the Great Depression is coming to an end.

Unemployment was 12.4 percent in May, 2.7 percentage points higher than the national rate. Lawmakers gridlocked over how to close a $19 billion budget gap are weighing the termination of the main welfare program for 1.3 million poor families or borrowing more than $9 billion in the bond market. California, tied with Illinois for the lowest credit rating of any state, is diverting a rising portion of tax revenue to service debt, Bloomberg Markets magazine reports in its August issue.

Far from rebounding, the Golden State, with a $1.8 trillion economy that’s larger than Russia’s, is sinking deeper into its financial funk. And it’s not alone.

Even as the U.S. appears to be on the mend — gross domestic product has climbed three straight quarters — finances in Arizona, Illinois, New Jersey, New York and other states show few signs of improvement. Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June, according to the Center on Budget and Policy Priorities, a Washington research institution. State spending is 12 percent of U.S. GDP.

“States are going to have to cut back spending and raise taxes the same way Greece and Spain are,” says Dean Baker, co- director of the Center for Economic and Policy Research in Washington. “That runs counter to stimulating the economy and will put a big damper on the recovery in the latter half of this year.”

State budget woes are a worsening drag on growth as the federal government tries to wean the economy from two years of extraordinary support. By Jan. 1, funds from the $787 billion federal stimulus bill will dry up. That money from Washington has helped cushion state budgets as tax revenue has plunged.

State leaders won’t be able to ride out this cycle the way they have in the past. The budget holes are too large. For the first time since 1962, sales and income tax revenue fell for five straight quarters, through December 2009, according to the Nelson A. Rockefeller Institute of Government at the State University of New York at Albany.

Lawmakers need to overhaul tax policy, underfunded public pensions and entitlement spending programs such as Medicaid if they want to establish long-term plans that will foster growth, says former New Jersey Governor Christine Todd Whitman.

“States don’t have a choice anymore,” Whitman says. “These problems are going to require major surgery.”

On May 20, New Jersey Governor Chris Christie vetoed a Democratic bill that would have raised income taxes for residents earning at least $1 million a year to help close an $11 billion deficit. Christie, a Republican, wants to cut spending for school districts and cap property tax increases.

“At some point, the people’s ability to pay runs out,” Christie said in a speech in New York on May 25.

Day of Reckoning Arrives

The Bloomberg article is nothing new. I have been harping about this for years. However, the arrival of the day of reckoning is new. Yet, the only state governor actively doing anything that makes much sense is New Jersey governor Chris Christie. The rest are limping along waiting for the mid-term elections.

However, it is increasingly apparent the next Congress will look a lot different than this one as a Midterm Disaster Looms for Democrats as Confidence in Obama Wanes.

Tenuous Passage

Just to show you how tenuous things are already, financial reform is back up in the air because Massachusetts Senator Scott Brown is having second thoughts about last minute changes rammed in by Democrats.

Reuters reports Senator’s concern may complicate Wall Street bill vote

“I was surprised and extremely disappointed to hear that $18 billion in new assessments and fees were added in the wee hours of the morning by the conference committee,” Massachusetts Senator Scott Brown said.

He issued the statement after negotiators from the Senate and House of Representatives emerged from a marathon session early Friday morning with a final compromise on a bill that would bring about the most sweeping financial rules revamp since the 1930s.

The legislation would set up a new financial consumer watchdog, create a protocol for dismantling troubled financial firms and mandate higher bank capital standards — all in an effort to avoid a repeat of the 2007-2009 credit crisis that hammered the economy and triggered taxpayer bailouts of floundering firms.

In May Brown was only one of four Republicans who voted for the Senate’s financial regulatory reform package, which was approved, 59-39, with two members not voting.

Before that vote, Democrats had to overcome a Republican filibuster aimed at killing the bill and did that by the narrowest margin possible, 60-40.

Brown’s possible defection from the bill increases the chance of a successful Republican filibuster this time unless Democratic leaders can find another vote.

Democrats control 57 seats in the Senate and Republicans 41. Two independents usually vote with the Democrats. It takes 60 votes to end a filibuster.

“While I’m still reviewing the bill’s details, these provisions were not in the Senate version of the bill which I previously supported … I’ve said repeatedly that I cannot support any bill that raises tax,” Brown said.

Much Ado About Nothing

Financial reform will pass of course, but barely. Would it pass after the upcoming election? Doubtful.

Moreover the reform that did pass will not accomplish a damn thing. Barry Ritholtz writes Stop the Next Crisis? This wouldn’t have stopped the last one . . .

I cannot help but be struck by one thing in this reform bill:

If it were law since the year 2000, the only part of it that might have prevented, or at least slowed down the crisis, was the new minimum underwriting standards for mortgages. No more “No Doc, NINJA, or Liar loans.” That Lenders must verify income, credit history and job status certainly would have prevented the worst vintages of sub-prime and exotic mortgages from ever being written, or subsequently securitized.

Other than that, there is not a single element of the reform that would have prevented the last crisis. I strongly doubt that anything else in this reform package is going to prevent the next one, either.

Ritholtz is spot on with those comments.

The key take away is it took months of time and energy to accomplish nothing, while barely garnering enough votes for passage (assuming it does pass).

Unemployment Extension Fails To Pass After Three Tries

As further proof Congress is fed up with deficit spending please consider Senate Dems fail to advance tax extenders bill for the third time

Senate Democrats on Thursday failed for a third time to advance legislation to extend unemployment benefits through November.

The 57-41 vote rejected ending debate on the legislation, which would have sent the bill to a final vote.

After the vote, Senate Majority Leader Harry Reid (D-Nev.) repeated comments he made earlier Thursday that the Senate will now move to a small-business bill. Reid said the unemployment benefits would not be added to that bill, but others have speculated that the provisions could still be attached to the small-business measure.

The failure to move the tax extenders package, which also would have renewed scores of individual and business tax breaks, illustrates the extent to which fears about the deficit are dominating the legislative process five months before a midterm election in which Democratic control of Congress will be on the line.

The legislation cost about $100 billion and would have added roughly $33 billion to the deficit by extending unemployment benefits for six months. The cost of the added unemployment insurance was not offset with other tax hikes or spending cuts.

Republicans unanimously voted against the motion, arguing it would add to the country’s ballooning deficit.

“We just can’t keep kicking the can down the street and say, ‘Oh, we’ll take care of it later on. It’ll be offset later,’ ” Sen. George Voinovich, a centrist Republican from Ohio, told The Hill. “That’s all we’ve been doing these last couple of years, and I’m fed up with it.”

I do not know if the extension passes this session or not. However, I offer the point of view that it is increasingly harder to pass such measures and it may be impossible after the next election.

These signs make it a lock that the financial day of reckoning for states has arrived. It’s about time. Now all we need are a lot more governors like Chris Christie willing to tell the public unions where to shove it.

Mike “Mish” Shedlock
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