Crisis at City and State Levels Reaches “Danger” Level

The City of Stockton, California, borrowed $35.0 million to buy a new eight-story city hall building. However, the move from the old building was never made, because Stockton could not keep up with the payments due to its rising budget deficit. Wells Fargo, the bank that owns the building, seized it from Stockton (source: ABC News 10, May 31, 2012).

Wells Fargo also seized three parking garages from Stockton. As you can see, the city is struggling with its massive budget deficit.

As government debt continues to mount and budget deficits widen at the municipal and state levels, there will unfortunately be other such stories in the coming days and months.

Illinois recently needed to raise $1.8 billion in new debt in order to finance its budget deficit. Since Illinois has the highest debt level of all states, its interest rate costs on the $1.8 billion increased by 25% (source: Bloomberg, April 30, 2012). That is millions of dollars more in interest payments, which of course increases Illinois’ government debt and the budget deficit.

Sadly, Illinois is going to have to introduce some very difficult cuts to its pensions and its services to its citizens in order to close the budget deficit.

An unprecedented—it is amazing how often that term has been used in the pages of Profit Confidential and will continue to be used this year as the economy worsens—vote has taken place in two of the largest cities in the country: San Diego and San Jose, California.

Voters had a choice between reduced essential services in their communities and cutting retirement benefits for not just new city employees, but also current working city employees, in order to reduce the budget deficits. The voters overwhelmingly chose to cut the retirement benefits in order to pay for the budget deficits (source: Associated Press, June 11, 2012).

Both cities are passing the measures, but unions that are directly affected are suing the city, saying it cannot renege on its pension promises.

San Diego is arguing that its pothole-riddled roads are left abandoned, while the city libraries had to reduce their hours of operation to conserve money to meet their budget deficit. San Jose in the meantime has four libraries and a police station that have been left abandoned for years, because the city cannot find room in the budget deficit to operate them.

It is these realities that forced the citizenry to vote for the measures, to the detriment of the public workers.

Of course, other states that are struggling with high government debt and widening budget deficits now want to enact similar votes. Although they will most likely be unsuccessful, the unions in those cities will follow the lead of the unions in San Jose and San Diego and take the matter to the courts.

The implications of these court battles cannot be understated. If the city wins, there will continue to be massive cuts to people’s pay as budget deficits are reduced, which will eat into consumer spending and so lower gross domestic product (GDP) growth.

If the unions win, then the cities will beg their states for money, and with the states having none, the next step is to run to the White House for answers to city and state budget deficit problems. This means more government debt and money printing or a complete overhaul of the pension system.

Where the Market Stands; Where it’s Headed:

It’s been four years now since the credit crisis hit, dear reader. And what are we left with? We are left with a 50% increase in the U.S. national debt, a central bank that buys government debt, and a multi-trillion-dollar increase in the money supply.

And, yes. We are left with a stock market that trades wildly on rumors of money printing. If statistics say the economy is doing badly, the prospects of a third round of quantitative easing (QE3) looks good and the market rallies. If the statistics say the stock market is improving, and QE3 might not happen, the market falls.

My opinion remains unchanged: Q3 will happen. So will QE4 and QE5. The bear market rally in stocks will have its last hurrah as the money supply expands. Phase III of the secular bear market will follow the current rally, pushing stock prices sharply lower.

What He Said:

“As for the stock market, it continues along its merry way oblivious to what is happening to homebuyers’ wealth. (Since 2005 I have been writing about how the real estate bust would be bigger than the boom.) In 1927, the real estate market crashed and the stock market, even back then, carried along its merry way for two more years until it eventually crashed. History has a way of repeating itself.” Michael Lombardi in Profit Confidential, November 21, 2007. A dire prediction that came true.