When 8 States Defaulted: Could It Happen Again?

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When 8 States Defaulted: Could It Happen Again?
Will Higher Taxes Keep the Wolf from States' Doors?

By Bob Stokes
Wed, 12 Jan 2011 20:15:00 ET

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"I can’t imagine a scenario where we see a major state default."

This is what the CEO of a Chicago financial firm told CNBC (1/4).

But did you know states have defaulted on debts before?

It happened during a time in our history when real estate values had soared, and states were spending like there was no tomorrow. But tomorrow came.

A Wall Street Journal article (Jan. 4) returns us to the time of the first major depression in the U.S.:

"...it all went bust, bringing down banks and state governments with them. This wasn't America in 2011, it was America in 1841, when a now-forgotten depression pushed eight states and a desolate territory called Florida into the unthinkable: They defaulted on debts.

"In Indiana and Ohio, property taxes went up eightfold in the early 1840s."

The CEO also said that unlike corporations, states have the authority to tax, which decreases the chances of a state defaulting.

Indeed, tax increases are a part of the "comeback" financial strategy today in California and Illinois.

Gov. Jerry Brown proposed a budget that would...maintain a series of tax increases for five years to close California’s huge budget deficit.

Associated Press (1/10)

"Illinois Gov. Pat Quinn defended a massive increase in state income taxes...Lawmakers worked overnight to pass the increase to raise the personal income tax rate from 3 percent to 5 percent for four years -- a 66 percent increase...The rate increase might be the biggest any state has adopted in percentage terms while grappling with recent economic woes."

Associated Press (1/12)

Along with that huge percentage increase in state income taxes, Bloomberg reports (1/3) that the Illinois Legislature is considering five new casinos, and authorizing electronic gaming at horse-racing tracks and several other existing casinos.

Where have we heard about that before?

"Some government-run investment funds are recklessly rolling the dice...In Illinois, for instance, the state pension fund is using derivatives to “recoup returns”...In Detroit, the pension fund for police and fire departments invested millions in a casino venture that has been downgraded three times by rating agencies. These schemes are vestiges of the old bubble era that will steepen the cost to taxpayers and pensioners."

Elliott Wave Financial Forecast, July 2010

But will new taxes and revenue schemes turn the financial trick for states? In other words, is the talk about state and local government defaults all bark with little chance of a bite?

Well, there's already been a "first time" for state defaults -- during the deflationary depression of 1835 to 1842, as the Wall Street Journal described. The deflationary trend we see unfolding now may prove to have more in common with that time than anyone today imagines.

Just follow this link for your risk-free read of our Financial Forecast Service. (2011 appears to be a pivotal year.)

Tags: bailouts, credit rating, economic depression, pension funds

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