A New Model for Government Default
Long-term economic waves or credit cycles deserve much more serious consideration by mainstream economists. The work of Andrey Kondratiev, though flawed, points the way. It states that the world economy goes through 70-year credit cycles that only end with widespread destruction of credit, i.e., default. Once the credit slate has been cleared, the economy can grow again for a new cycle. Even the Bible contains a version of this wisdom, in the form of the yovel or Jubilee.
Looking at long term credit cycles, the backbenchers in the German Parliament have it right. No pain, no gain. Barack Obama’s masterful execution of the GM bankruptcy is a case in point. Everyone had to lose – executives, stockholders, bondholders, litigants, pensioners, employees, suppliers, crash victims, local taxing authorities, and car owners – before a new viable, right-sized GM could rise from the ashes.
In Greece, the same pattern can be observed. An entire country is experiencing the payback from 60 years of excessive credit, wage and benefit expansion. Pensions have been cut, the minimum wage reduced by 22%, the military budget slashed and medical insurance curbed. Amongst government workers, even first responders, suffered a pay cut. Greek bondholders have lost £90 billion -- 53.5% of their principal. Let us hope that the Greek slate is finally clean and that the country can start anew and create a vibrant economy for a new generation.
Looking at New York State, this week, due to the extraordinary leadership of Governor Cuomo and Mayor Bloomberg, a major step was taken towards fiscal sustainability with the passage of Level VI Pension Reform. But that may not be enough ‘pain’ to set off a new cycle of economic growth and credit expansion.
All of the existing, unaffordable pension commitments were honored – no contributions, full retirement pay at 55, pension padding through sick days and unused vacation -- meaning that the Tier VI reforms will not take full effect for three decades. Can New York State and its 7 tiers of local government wait 30 years to get their fiscal house in order?
A better approach would have been to amend the bankruptcy or solvency laws covering state and local governments. Such a new law could enshrine the “GM bankruptcy loophole” as the new governmental insolvency model. This model would entail creating New New York entities and Old or Toxic New York governmental entities. The New New York entities would have no employees, no labor contracts, no pension obligations, no medical insurance, no outstanding litigation, no real estate leases, no supplier contracts or funding commitments -- real zero-base budgeting -- just the exclusive right to tax the citizens of New York in their jurisdiction. The Old New York entities would have all the fiscal baggage accumulated over the past 70-year credit cycle. The new entities, just like the New GM in the brilliant Obama bankruptcy process, would enter into new contracts with their employees, landlords and suppliers, leaving in the Old New York entities – just like the old GM – all of the debts accumulated during 70 years of obligation accretion. The old entities would hold all the unaffordable pension obligations, retiree medical commitments, interest and principal obligations to bondholders, lawsuits, structured settlements, vendor contracts, funding agreements to other government entities etc. It would be a massive list. The Old New York entities would default on these obligations and cease payment until a deal could be worked out. Obama did it in 90 days at GM; where there is pain, there is action.
Just like the New GM gave the Old GM a stake in its future – in the case of Old GM it got 30% of New GM – the New New York entities would give the Old New York entities a claim to their future revenues – for example, 30% of tax receipts for 50 years. With this claim as a backdrop, the Old New York City would negotiate with its stakeholders regarding the ‘haircut’ that each group would suffer until a deal could be reached that ‘spread the pain’ across all groups of stakeholders. For example, the pension ‘haircut’ could be set at the ERISA maximum, $55,480 per year at age 65.
Old line capitalists and Wall Street investment bankers will say that such a plan will destroy the municipal bond market and that bondholders should get all their money back before pensioners, suppliers, landlords or litigants get anything – that is what the State of Rhode Island has enacted into law. But the genius of the GM bankruptcy was that this age-old principle of was not applied – the bondholders shared in the pain with the other stakeholders, just like the Greek private bondholders did last week.
Enacting a State-wide fiscal reset would involved a short period of intense pain and economic hardship – shock treatment to the max -- but it would result in healthy governmental entities that could provide the services and investments in infrastructure needed to prosper and set the stage for new economic growth based on a new long-term expansion of the credit cycle.
Like the yovel or Jubiliee in the Bible or the predictions of Mr. Kondratiev, we wouldn’t have to go through such a reset again until at least 2052.
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