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State and Local Finance

Senators Seek Ways To Assist Failed States

WASHINGTON — Senate Budget Committee chairman Kent Conrad said Friday that his panel needs to come up with a plan to help states that approach Congress seeking ­assistance because of serious financial troubles.

The North Dakota Democrat made the remark at a hearing where committee member John Cornyn, R-Tex., pressed ­Federal Reserve Board chairman Ben Bernanke, who testified about the economy, whether lawmakers should draft legislation that would permit states to file for bankruptcy.

“Senator Cornyn is exploring ways to address the state financial crisis, including amendments to the bankruptcy laws,” a ­spokesman said. “A federal bailout of state governments is not an option.”

The hearing took place in the wake of recent projections by analyst Meredith Whitney that state and local fiscal crises could result in defaults on hundreds of billions of dollars of municipal bonds.

Asked about those projections, Bernanke conceded that many state and local governments are under fiscal stress, but said: “We don’t at this point see anything of that magnitude happening.” State and local governments have the tools to deal with their fiscal problems and debt, and the municipal bond market “currently seems to be functioning reasonably well,” he said.

Committee member Rep. Joe Manchin, D-W.Va., former chairman of the National Governors Association, asked Bernanke if the Fed has looked at the possibility that states will default on their muni bonds, particularly after they stop receiving stimulus funds in June.

“No question, state and local governments are under a lot of pressure,” Bernanke responded. He noted that they face budget gaps and unfunded pension and health care liabilities in the longer term, and have been cutting spending and ­employment over the last couple of years.

The “bottom line,” Bernanke said, is that there is a lot of liquidity and issuance in the muni bond market and it “seems to be doing okay. But clearly there’s a lot of both near-term and longer-term pressure on these governments and it’s going to be something that’s not going to be going away in the near term.”

Bernanke said the Fed will continue to monitor the situation. “I think cities and localities will need to take strong measures to avoid default,” he said, adding that “default is only at best a short-term solution” or “a last resort” for governments because it would make it difficult for them to return to the muni market.

Bernanke pointed out that debt typically takes priority over services when states do not have the money to pay for everything.

Cornyn asked Bernanke if the Fed would ever consider buying state or local debt. “We do have the authority to buy very short-term municipal debt that is within certain categories,” Bernanke said.

 He noted that the Dodd Frank Wall Street Reform and Consumer Protection Act restricts the Fed’s ability to lend to any insolvent borrower or individual borrower, unless it is through a broad program.

“We have no expectation of intention to get involved in state and local finance,” Bernanke said. “I think to the extent that there’s anyone to look at that, it would have to be Congress.”

Asked by Cornyn about Congress drafting legislation to permit states to file for bankruptcy, Bernanke said: “I think it would be useful for Congress to look at the situation broadly and try to identify what potential problems there might be. It would be extraordinarily unusual for a state to default. It hasn’t really happened seriously for 160 years or so. I think we ought to focus on states meeting their obligations, which they do have the tools to do.”

Manchin, who said he thinks 20 to 30 states “could be in serious problems,” asked if the Fed has plans to prevent states from defaulting on their debt. “I don’t think the Federal Reserve has the authority and I don’t think it would be appropriate for us to do that,” Bernanke responded.

Conrad said the Committee on Budget and Policy Priorities reported that state budget gaps total $113 billion and are expected to grow to $140 billion. At least 35 states are projecting gaps for 2012, he said, citing Illinois, Arizona, Washington, California and Texas as among those with the greatest gaps in 2011.

“We’re talking about a significant problem here,” he said.  “We need to be prepared with a plan in case we are approached by one or more states.” But he added,  “I don’t think ... the House or the Senate are going to be very interested in bailouts to states.”

Manchin said states are “going to have to have the flexibility to refinance, to put their financial houses in order. ... There might be some creative financing that’s needed to be done.” He said the committee should be considering helping states along the lines of: “Can we help you help yourself? Can we give you some flexibility? Are there some restrictions and regulations that we could ease up on?”

“What you’re saying, I think, makes eminent sense,” said Conrad. “That is, maybe there are ways to help with creative financing.”

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