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The 2011 fiscal year for 46 states begins in 10 days. In many cases it is a countdown to financial doom.

Despite what you may have heard from conservative sources, state and local government have been cutting and cutting. 231,000 state and local government jobs have vanished since August 2008 - 22,000 in just the past month. Most of those jobs were at the local level, such as police, firefighters, and school teachers.

The fat has already been trimmed. The muscle has been cut into. There is nothing left to cut but bone.

At least 19 states are getting the saws ready, because knives won't cut bone.

According to Mark Zandi, the chief economist at Moody’s, states are facing a budget gap of $180 billion next year. The shortfall could lead to the destruction of 900,000 jobs at the state level, an employment source that is often thought of as an economic safety net.

Up to 300,000 of those laid off will be school teachers, and some estimate the total number of government workers to be let go in the 1-to-2 million range.

California has already cut 62,000 government jobs.

This is only the start. Cities and counties up and down the state are openly debating bankruptcy.

Street expects more talk of municipal bankruptcy across California because local government finances are in such dire shape -- a situation underscored on Wednesday when a top finance officer for Sacramento County projected a worse-than-expected shortfall for the county of $181 million, which could force more than 1,000 layoffs from the county's payroll.

"You don't have the easy out of increasing revenue and you have a lot more call on services because of the economy," Street said. "There's no such thing as entertaining bankruptcy; there's ending denial."

The City of Antioch wants to "alert people to the possibility". Los Angeles has described bankruptcy as "inevitable". A county grand jury has recommended San Diego to declare bankruptcy.

Despite all these horrendous headlines, amazingly California isn't the state considered most likely to default; Illinois is.

Illinois’s credit-swap costs surpassed California’s, the largest U.S. municipal borrower, which saw its default-insurance contracts rise 1 basis point to 299.6 basis points from 298.7 basis points yesterday.

Illinois budget deficit is equal to half of its proposed budget.

The budget disasters spread far and wide.

The fiscal year in New York started months ago, but a real budget is still a work of fiction. The state has been getting by on one-week budgets, and it can't continue. A showdown that might produce the state's first shutdown in history could happen by the end of the month. New York has an $8 Billion budget hole to close this year, and another projected $5 Billion deficit next year.

To give you an idea of how bitter and outrageous the budget talks have been, New York conservatives have accused Governor Patterson's proposed tax increase on tobacco sales of aiding terrorists.

Budget problems aren't just for big cities and states.   Arizona's deficit is expected to be 30% of its budget. It is spending $10.1 Billion, but only taking in $6.4 Billion.

Oregon is facing a 10% budget shortfall.

State spokesperson Anna Richter Taylor said. "It very likely will result in layoffs, although that is the option of last resort."

"The reality is the state does not have $560 million to fill this hole," she said.

The Rust Belt cities are also on the ropes. Harrisburg, PA, and Detroit, Michigan, are considering Chapter 9.

Even the city of Miami is facing bankruptcy.

Investors so far have ignored the warning signs in the municipal bond market, but some experts are raising the alarm.

"The day of reckoning is here," says Jeffrey Schoenfeld, chief investment officer of Brown Brothers Harriman. "But municipal investors continue to act as if there's no default risk in municipal bonds."

"I don't know how I would rate them myself," Mr. Buffett testified. "It's a bet on how the federal government will act over time."

Today's municipal bond market is a crooked mess. On one side you have corrupt Wall Street investment bankers rigging the system to exploit ignorant government workers and the taxpayers they represent.

"The whole investment process was rigged across the board," said Charlie Anderson, who retired in 2007 as head of field operations for the Internal Revenue Service's tax-exempt bond division. "It was so commonplace that people talked about it on the phones of their employers and ignored the fact that they were being recorded."

On the other end of the system are local politicians, who refinanced bonds over and over again to use the proceeds on unrelated projects.

Systemic Failure

You can't just keep cutting and cutting services and manpower before the system stops working.

Case files piling up by the thousands, phones ringing off the hook, forced midweek courthouse closings and occasional brawls as frustrated citizens queue for hours to pay parking fines.

"People think we’re becoming a Third World country," said Ms. Sims, 55.
"We are on the verge of system failure,"
warned Jean Ross, executive director of the California Budget Project, an independent think tank based in Sacramento.

At a certain point the potholes don't get filled, the police don't respond (at least not in poor neighborhoods), sewer systems break and don't get fixed, kids can't get into college, people get "lost" in the judicial system, and eventually citizens simply give up on the government.

We are facing the threat of losing something very basic - our idea of what America should be like. Once that is gone, it doesn't come back.

It's a matter of priorities.

When California Gov. Schwarzenegger proposed the latest budget, he completely eliminated the welfare programs in the state, as well as most child care funding. It would save the state about $2.2 Billion, but cost tens of thousands of public and private sector jobs.

What Schwarzenegger left in the budget was $2 billion in planned corporate tax breaks.

Schwarzenegger made a choice - corporations over poor children. This choice is getting very popular with politicians in recent years.

When conservatives in Washington shot down the unemployment extension, leaving millions of poor, working class people and their dependents without any support, it was partially because of their opposition to business taxes.

The poor need better lobbyists.

California is facing a $19 Billion deficit this year, and a $37 Billion deficit next year. Between 2010 and 2011, U.S. States are looking at a $300 Billion shortfall.

Republican candidate Meg Whitman says she intends to solver the California budget by getting rid of 40,000 workers. I wonder if Whitman is willing to start with the department who's employment has increased 123% in the last 20 years, accounting for one third of total growth - the Department of Corrections? Schwarzenegger didn't.

California already has the 2nd lowest number of state employees per capita, lower than such states as Arizona and Texas, and at the same level as it was in 1970. Only 17.8% of the California state budget goes to salaries and wages.

At what point do politicians have to admit that police, firefighters, and school teachers aren't the reason for the budget problems?

Revisiting the Perfect Storm

When I wrote A perfect storm for unemployed a month ago, I never dreamed that I had underestimated the problem.

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I didn't think that Congress would balk at renewing the unemployment extensions. This has left 1.2 million long-term unemployed with no lifeline, while Senator Hatch implies that they are all worthless drug fiends.

I didn't think that Congress would balk at matching the state's medicaid programs in middle of this depression. Without this money the state budget cuts will be draconian, if even possible.

Meanwhile, the expected layoffs from the census are going to happen on schedule, while federal stimulus money slowly dries up.

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Given all this, and the state budget crisis, its hard to see how this isn't going to force the unemployment rate up.

[Update:  Brown Brothers (BBH) warned of the economic impact of the state and local government cutbacks.

  "The essay does warn that the cutbacks by state and local governments will retard the US economic recovery for the next year or two. These cuts have blunted the impact of increased federal stimulus. Going forward, perhaps after the November Congressional elections, the increase in federal spending will also slow, reducing its offset of state and local budget cuts. The US may face a greater fiscal drag than many observers suspect due to the impact of state and local government fiscal conditions. Investors would do well to consider the possible impact of similar fiscal conditions in European regions and cities."

 The study also addresses public sector to private sector pay. It finds public sector pays about 2% more than private sector.

Originally posted to gjohnsit on Mon Jun 21, 2010 at 09:41 AM PDT.

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