States and cities are in the same fiscal mess as the federal government

For many years, official Washington — its own "echo chamber," as some say — has been ignoring the financial needs and prospects of state and local governments.

That era is now coming to a crashing end.

The headline event is Gov. Arnold Schwarzenegger's appeal to the U.S. Treasury for an emergency $7 billion loan to cover California's immediate operating expenses. Massachusetts has submitted a request too.

The Wall Street fiscal crisis effectively shut the state-local government sector out of borrowing — either for long-term bonds or, of more immediate gravity, bridge loans to keep them afloat awaiting sales tax and April income-tax receipts.

But the stage for a "perfect fiscal storm" was already set by the seriously weakened fiscal condition of so many state and local governments. On top of the stunning $43 billion in prospective deficits that 29 states had to cover with spending cuts or tax hikes for the fiscal year starting July 1, at least 15 of the states have already seen serious new budget gaps emerge, reports the Center on Budget and Policy Priorities.

Indeed, versions of California's budget crisis are being registered from Georgia to Arizona, Florida to New Jersey to Ohio. In New York, epicenter of the financial earthquake triggered by Wall Street's complicity in the mortgage foreclosure mess, fears of massive layoffs by financial houses are expected to add $1 billion or more to the $5.4 billion deficit the state already faced.

State-local taxes will surely have to rise: By global standards, we're in fact a relatively low-tax nation. And the financial wizardry that helped trim bond-sale costs in recent years is likely toast — we'll see a return to plain-vanilla bonds with fixed rates of interest.

Then there's the impact of the stock market plunge on state and local pension systems with their estimated $3 trillion in long-term liabilities. The funds' expected investment returns of roughly 8 percent are now wildly unrealistic. Unfunded liabilities, notes John Petersen of George Mason University, a senior analyst of state-local fiscal systems, "will probably grow exponentially."

The often-ignored reality, says Petersen, is that state and local budgets are 12 percent to 13 percent of the entire national economy. "In the last (2000-01) recession, they held up because property taxes were doing well. But now it's the fatal storm — everything is going down. It's a 9/11 for government finance."

Yet there may be something of a silver lining, Petersen suggests: "This financial — and now fiscal — crisis means we're all in this together. We will need strong government — federal and state-local — to lead us."

Nationally, that's already clear. The federal bailout of major banks, insurance companies and mortgage lenders proves free-market fundamentalism doesn't work, that careful and thorough government regulation and oversight are imperative.

But to fashion a full recovery policy, official Washington will be obliged to work more closely with state and local governments, devising major fiscal-recovery plans, shared agendas and reasonable regulation.

An immediate example: We're seeing 10,000 foreclosures a day. In the next year, about 1 million to 2 million adjustable-rate mortgages are due to adjust upward. The local impacts may be devastating, requiring fast federal action (perhaps fast revisions of the bankruptcy code).

An active debate is already necessary: Should Congress approve billions of dollars in revenue sharing for states and localities hard hit by the decline in tax revenues caused by the foreclosures federal inattention triggered, and falling property values?

The shaken national economy and depression of state and local tax bases may indeed last several years. How could we not plan a serious federal-state dialogue — starting in weeks, as soon as a new president is elected — on remedial steps?

The opportunity for frank and realistic discussions, a new intergovernmental compact, is strengthened by the emergence in recent years of "a really strong generation of governors, bottom-line managers, who watch their agencies week by week and hold their managers accountable." Making that case, Neal Johnson of the Pew Center on the States points to such reform-minded governors as Martin O'Malley (Md.), Christine Gregoire (Wash.), Tim Kaine (Va.), Jon Huntsman (Utah), Jennifer Granholm (Mich.), Mitch Daniels (Ind.) and Ted Strickland (Ohio).

In every field from transit funding to Medicaid, says Johnson, "we need to open a frank dialogue on who's responsible for what, recognizing we are all in the same boat together."

Actually, before Ronald Reagan killed it, we had a national Advisory Commission on Intergovernmental Relations, focused on just such issues. Its top fiscal analyst, John Shannon, often told me: "It's an ill wind that doesn't bring some good."

Maybe — just maybe — today's ferocious fiscal hurricane could restore a breeze of dialogue and rationality. It's high time to get America's governments — and the metro regions so critical to our economy — onto the same page, thinking through, planning survival strategies for perilous times.

Neal Peirce's column appears regularly on editorial pages of The Times. His e-mail address is nrp@citistates.com