Institutions that are not likely to pay their bills have to offer higher interest rates for capital. Old rule. Usually works. Credit agencies issue ratings which allow investors to decide how much risk they can stomach. That part of the system turned to dust during the credit crisis.
Now that evaluating debt has regained some of its equilibrium, one of the focuses on potential default levels has turned to states and municipalities.
According to Bloomberg, "California’s fiscal crisis pushed yields on tax-backed debt to a four-year high as the state struggles with a $42 billion budget deficit." Michigan, Florida, and Rhode Island are facing similar problems and those troubles are about to spread to other large states such as New York.
High interest rates always tag the entities that cannot afford to pay them out. Whatever assistance states are going to need from the federal government is going to get more acute as they look at the price they will have to pay for capital.
Bailing out a dozen or two dozen states with huge deficits may be beyond what Congress and the administration can stomach.
The only solution may be to offer states low interest loan guarantees. That may work. It would cost the federal government less money than a massive state bailout program. But, it may not be enough, which means the problem will be sent down the road to be revisited like almost all the other financial troubles which have popped up over the last year.
Douglas A. McIntyre