Financial mistakes and chronic overspending by government officials are generally covered over by increasing taxes or selling bonds. Overspending can continue until that government entity is prevented from using either mechanism and is forced to deal with the consequences of their unsustainable financial situation. Although increasing taxes and selling bonds can go on for years or decades, depending on the size of the government entity, but sooner or later, a reckoning with financial reality must occur.
This reckoning with reality arrives in 4 common stages and you will recognize them in the news, recurring over and over from across the country and globe:
- Continuing to increase taxes to pay for financial mistakes and unaffordable obligations.
- Credit rating falling which makes it more expensive to sell bonds.
- Debts consume a larger portion of budgets which siphons money away from normal government services. Residents then complain by voting out the incumbents, but it is too late and parties are too intractable to reach a sustainable agreement.
- Bankruptcy or settlement. Where a judge or creditor committee rules on how little all of the creditors will actually receive, including bondholders and pensions.
Current examples of governments in these 4 stages of financial distress:
- Detroit’s Wayne County is headed toward bankruptcy, exactly following the city of Detroit did two years ago. The county has a structural deficit of $50 million that no tax hike can fill.
- The city of Chicago’s credit rating was recently dropped below investment grade to junk and laid off 1,400 school administrators to fund a pension payment.
- The state of California continues to ratchet up swaths of their already-high tax rates to fund their escalating liabilities for pensions, health care, and high-speed rail projects.
- Greece’s economy has hit a wall after defaulting on their sovereign bonds with the IMF and may get kicked out of the Euro currency; Greek banks have issued stringent capital controls. How this unfolds will affect Italy, Spain, and other insolvent debtors using the Euro currency.
- The territory of Puerto Rico hired bankruptcy attorneys as it is about to default on $72 billion in debt that it can never repay.
- Venezuela just issued more capital controls on Venezuelan’s traveling abroad (reducing the currency they can exchange) to delay their inevitable default on bonds.
- Argentina has been going through bond restructuring (bankruptcy) since this January.
- And you may remember that the credit rating for the U.S. Federal Government was downgraded in the summer of 2011; from the highest rating of AAA down to AA+.