[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]





              STATE AND MUNICIPAL DEBT: THE COMING CRISIS?

=======================================================================

                                HEARING

                               before the

                SUBCOMMITTEE ON TARP, FINANCIAL SERVICES
              AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

                                 of the

                         COMMITTEE ON OVERSIGHT
                         AND GOVERNMENT REFORM

                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                            FEBRUARY 9, 2011

                               __________

                           Serial No. 112-40

                               __________

Printed for the use of the Committee on Oversight and Government Reform








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              COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

                 DARRELL E. ISSA, California, Chairman
DAN BURTON, Indiana                  ELIJAH E. CUMMINGS, Maryland, 
JOHN L. MICA, Florida                    Ranking Minority Member
TODD RUSSELL PLATTS, Pennsylvania    EDOLPHUS TOWNS, New York
MICHAEL R. TURNER, Ohio              CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina   ELEANOR HOLMES NORTON, District of 
JIM JORDAN, Ohio                         Columbia
JASON CHAFFETZ, Utah                 DENNIS J. KUCINICH, Ohio
CONNIE MACK, Florida                 JOHN F. TIERNEY, Massachusetts
TIM WALBERG, Michigan                WM. LACY CLAY, Missouri
JAMES LANKFORD, Oklahoma             STEPHEN F. LYNCH, Massachusetts
JUSTIN AMASH, Michigan               JIM COOPER, Tennessee
ANN MARIE BUERKLE, New York          GERALD E. CONNOLLY, Virginia
PAUL A. GOSAR, Arizona               MIKE QUIGLEY, Illinois
RAUL R. LABRADOR, Idaho              DANNY K. DAVIS, Illinois
PATRICK MEEHAN, Pennsylvania         BRUCE L. BRALEY, Iowa
SCOTT DesJARLAIS, Tennessee          PETER WELCH, Vermont
JOE WALSH, Illinois                  JOHN A. YARMUTH, Kentucky
TREY GOWDY, South Carolina           CHRISTOPHER S. MURPHY, Connecticut
DENNIS A. ROSS, Florida              JACKIE SPEIER, California
FRANK C. GUINTA, New Hampshire
BLAKE FARENTHOLD, Texas
MIKE KELLY, Pennsylvania

                   Lawrence J. Brady, Staff Director
                John D. Cuaderes, Deputy Staff Director
                     Robert Borden, General Counsel
                       Linda A. Good, Chief Clerk
                 David Rapallo, Minority Staff Director

  Subcommittee on TARP, Financial Services and Bailouts of Public and 
                            Private Programs

              PATRICK T. McHENRY, North Carolina, Chairman
FRANK C. GUINTA, New Hampshire,      MIKE QUIGLEY, Illinois, Ranking 
    Vice Chairman                        Minority Member
ANN MARIE BUERKLE, New York          CAROLYN B. MALONEY, New York
JUSTIN AMASH, Michigan               PETER WELCH, Vermont
PATRICK MEEHAN, Pennsylvania         JOHN A. YARMUTH, Kentucky
JOE WALSH, Illinois                  JACKIE SPEIER, California
TREY GOWDY, South Carolina           JIM COOPER, Tennessee
DENNIS A. ROSS, Florida













                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on February 9, 2011.................................     1
Statement of:
    Gelinas, Nicole, Searle Freedom Trust fellow, Manhattan 
      Institute; Professor David Skeel, S. Samuel Arsht professor 
      of corporate law, University of Pennsylvania Law School; 
      Eileen Norcross, senior research fellow, Social Change 
      Project at the Mercatus Center; and Iris Lav, senior 
      advisor, Center on Budget and Policy Priorities............    14
        Gelinas, Nicole..........................................    14
        Lav, Iris................................................    43
        Norcross, Eileen.........................................    28
        Skeel, David.............................................    19
Letters, statements, etc., submitted for the record by:
    Cummings, Hon. Elijah E., a Representative in Congress from 
      the State of Maryland, prepared statement of...............    81
    Gelinas, Nicole, Searle Freedom Trust fellow, Manhattan 
      Institute, prepared statement of...........................    16
    Lav, Iris, senior advisor, Center on Budget and Policy 
      Priorities, prepared statement of..........................    45
    McHenry, Hon. Patrick T., a Representative in Congress from 
      the State of North Carolina, prepared statement of.........     4
    Norcross, Eileen, senior research fellow, Social Change 
      Project at the Mercatus Center, prepared statement of......    30
    Quigley, Hon. Mike, a Representative in Congress from the 
      State of Illinois, prepared statement of...................     8
    Skeel, Professor David, S. Samuel Arsht professor of 
      corporate law, University of Pennsylvania Law School, 
      prepared statement of......................................    21

 
              STATE AND MUNICIPAL DEBT: THE COMING CRISIS?

                              ----------                              


                      WEDNESDAY, FEBRUARY 9, 2011

                  House of Representatives,
      Subcommittee on TARP, Financial Services and 
           Bailouts of Public and Private Programs,
              Committee on Oversight and Government Reform,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 9:30 a.m., in 
room HVC-210, The Capitol Visitor Center, Hon. Patrick T. 
McHenry (chairman of the subcommittee) presiding.
    Present: Representatives McHenry, Guinta, Buerkle, Amash, 
Meehan, Walsh, Gowdy, Ross, Quigley, Maloney, Welch, Yarmuth, 
Cooper, and Cummings (ex officio).
    Staff present: Lawrence Brady, staff director; John 
Cuaderes, deputy staff director; Peter Haller, senior counsel; 
Christopher Hixon, deputy chief counsel, oversight; Robert 
Borden, general counsel; Joseph Brazauskas and John Zadrozny, 
counsels; Tyler Grimm and Ryan Hambleton, professional staff 
members; Michael Bebeau and Gwen D'Luzansky, assistant clerks; 
Molly Boyl, parliamentarian; Katelyn Christ, research analyst; 
Drew Colliatie, staff assistant; Adam Fromm, director of Member 
liaison and floor operations; Justin LoFranco, press assistant; 
Linda Good, chief clerk; Laura Rush, deputy chief clerk; 
Suzanne Sachsman Grooms, minority chief counsel; Jason Powell 
and Steven Rangel, minority senior counsels; Davida Walsh, 
minority counsel; Ronald Allen, minority staff assistant; Jesse 
Feinberg, minority legislative assistant; Lucinda Lessley, 
policy director; and Carla Hultberg, minority chief clerk.
    Mr. McHenry. The committee will come to order. This is our 
first meeting of the TARP, Financial Services and Bailout to 
Public and Private Programs. I will begin by making an opening 
statement.
    I certainly appreciate the panel of witnesses being here 
and taking the opportunity to be here. Today's hearing is an 
opportunity to discuss growing concerns over the potential 
fiscal crisis looming for States and municipalities. Over the 
past 3 years, we have seen a culture arise where every 
institution claimed it was too big to fail. An all-too-eager 
President and an all-too-compliant Congress kept putting 
taxpayers on the hook for trillions of dollars. Our budget 
deficit has reached an all-time high and the national debt is 
crippling our economy.
    Now we are facing the consequences of bad government policy 
in yet another way. State and municipal governments who are 
preparing for aggregate budget shortfalls totaling roughly $125 
billion this year are struggling under a trillion dollar burden 
of unfunded pension liabilities, plummeting tax revenues and an 
unforgiving bond market. We must understand the magnitude of 
this problem to avoid the reactionary ad hoc decisionmaking 
that fueled the Federal action of the 2008 financial crisis.
    This is not about one analyst. This is about the looming 
fiscal crisis in States and municipalities and the lack of 
transparency in their pension obligations. Let's be clear about 
this. The perfect storm is brewing. Already State and municipal 
governments are coming to Washington hat in hand expecting a 
Federal bailout like so many others. But the era of the bailout 
is over.
    That does not mean, however, that Congress must turn a 
blind eye or a deaf ear to the crisis unfolding in State and 
local governments. The beauty of federalism lies in the fact 
that the National Government does not tell the States how to 
manage their own affairs, at least ideally. The burden of 
federalism is that when one State, or all 50 States, are in a 
crisis, we must work together to solve them for the good of the 
country. Since 1990, State and local government spending has 
increased roughly 70 percent faster than inflation. The vast 
majority of the States now find themselves in a fiscal 
straitjacket caused primarily of the looming burden of paying 
out trillions of dollars in lucrative public sector union 
pensions and health care benefits that come at the expense of 
taxpayers.
    For the last 3 years, funding from the Stimulus Act has 
masked the severity of the State fiscal challenges. In fact, 
there was $140 billion in transfers from the total government 
to the States included in the stimulus. States now say that 
more money would help them through their current rough patch. 
The reality, however, is that the money States receive from the 
stimulus has, in many ways, made them worse off. A lot of the 
funding comes with ``maintenance of effort'' requirements that 
force States to keep funding programs after Federal funding 
dries up this year. More money from Washington would just delay 
the day of reckoning and only further complicate State fiscal 
situations. Besides, we don't have any more money. And beyond 
that the simple fact is that the government has outgrown our 
capacity to pay for it.
    There will be severe consequences for not changing course. 
Young teachers fresh out of college and ready to give back to 
their communities will be told that their school districts 
cannot provide them with reasonable retirement benefits because 
they are cash-strapped to pay for the exorbitant benefits of 
others. Firefighters, policemen and other public servants 
facing the reality that their vital jobs offer no promise of 
rising standards of living for their family or benefits will 
simply opt for a different career path.
    In the end, people will recognize that their government has 
failed them. But not only that, they believe that their 
government has actively hurt them.
    While we have the opportunity to change that, we are 
responsible to try. This is why we are here today, to come to a 
better understanding of the crisis at the State and local 
government level, to assess its causes and to consider 
available solutions. With that in mind, in this hearing and I 
intend to shed light on how the States arrived at their current 
predicament, what is the current extent of their fiscal 
distress, and what needs to be done in terms of available 
solutions.
    My friend and colleague from California, Representative 
Devin Nunes, has a proposal that would require greater 
transparency at the point of most urgent concern, the pension 
problem. I have been happy to work with him on this 
legislation. I look forward to hearing from both sides on any 
and all possible solutions, and that is why we have this great 
panel here today.
    Let there be no mistake though. Much is required to get our 
fiscal House in order not just at the State and local levels 
but here in Washington, DC.
    But reckless spending fueled by bottomless borrowing and 
guaranteed by endless bailouts is an unsustainable course.
    [The prepared statement of Hon. Patrick T. McHenry 
follows:]




    Mr. McHenry. And with that, I now recognize the ranking 
member, Mr. Quigley of Illinois, for 5 minutes.
    Mr. Quigley. Thank you, Mr. Chairman for holding this 
extraordinarily important and timely hearing, and 
congratulations on your new post as chairman. The record should 
reflect that you and your staff have been extraordinarily 
accommodating and cordial to myself and my staff. Obviously the 
issues are too important to divide us in any light, and I also 
thank you for doing that. Any time I take complimenting you 
shouldn't count against my time to speak.
    I want to thank our four witnesses for testifying today. 
And I agree, it is really in a sense not about bailouts or 
bankruptcies, because I don't think either one of those options 
can work, or is optimal. But as you know, I'm from Illinois, 
and you don't need to tell me about how bad its finances are 
and how critical these issues are. Illinois has gone through 
decades of bad financial decisionmaking under both Democrats 
and Republicans. Illinois now has an $8 billion backlog in 
payments, and a gaping $136 billion hole in its pension system, 
leaving its pension less than 50 percent funded.
    It should be no surprise then that the rating agencies has 
downgraded Illinois bond issuances several times in the past 
months. Last year Illinois bonds carried the worst credit risk 
of any U.S. State and were only slightly less risky than bonds 
from Iraq. According to Laurence Msall of the Civic Federation, 
this bad rating was costing Illinois taxpayers $551 million a 
year extra in interest payments. And total debt service in 
Illinois is expected to increase by 33 percent between now and 
the year 2017.
    The only way Illinois was able to climb out from a bottom 
rung was to raise State income taxes a whopping 66 percent, an 
outcome no one wanted.
    This tax increase brought Illinois's bond rating back up 
and reduced borrowing costs, but only by passing those costs on 
to Illinois taxpayers. Illinois has to reform its pension 
system, but it also has to reform its whole way of doing 
business which has left retirees vulnerable and taxpayers on 
the hook. As Professor Dershowitz said of Harvard's shrinking 
endowment after the 1990's boom, a lesson for all of us. People 
forgot the story of Joseph in Genesis, during the 7 good years, 
you save for the several lean years. Illinois didn't save for 
the 7 lean years and now it has to deal with the consequences. 
That said, what's going on in Illinois is not necessarily 
what's going on everywhere else.
    True, most States have recently rung up large deficits 
thanks to a collapse in tax revenues during the recession. But 
the short term fiscal problem will improve as our economy gets 
going again. The real problem is an actuarial problem unique to 
six to eight States, including Illinois which suffer from long-
term structural imbalances. The culprits are rising health 
costs, underfunded pension plans, and poor financial 
management.
    Some of these pension plans look particularly bad right now 
because of the collapse in the value of pension assets. But 
even an appreciation in asset value will lead several State 
pension plans underfunded.
    The municipal bond market is now responding to legitimate 
concerns about the long-term structural imbalances in these six 
to eight States. But I believe we would be correct to 
distinguish these bad apples from the other 40-some States that 
have been relatively well managed and only have temporary 
deficits. That is why a one-size-fits-all approach like 
bankruptcy for States could do more harm than good.
    What we have to avoid is any rash actions that would 
contribute new risk factors to the bond market. State and local 
governments across the country need to continue building roads 
and bridges, and we don't want to make the financing any more 
expensive than it already is. So we need to be crystal clear 
that although there are national interests at stake, the onus 
must be on those State governments to reform themselves. And 
they need to reform sooner than later, a default on payments 
would make it obscenely expensive for all States to borrow. 
Taxpayers would bear the brunt of these costs either through 
higher taxes or through reduced public services and a move 
toward austerity.
    Mr. Chairman I don't want an Illinois problem or a New 
Jersey problem to become a national problem. These States have 
to institute commonsense reforms to shore up their finances. At 
the same time government's mission matters, and successful 
reform will ensure that workers get the pensions they have 
earned through their years of service. All we need is the 
political will to get it done.
    I look forward to hearing from our witnesses on this matter 
and the discussions of the next possible steps. Thank you and I 
yield back.
    [The prepared statement of Hon. Mike Quigley follows:]



    
    Mr. McHenry. I thank you, Mr. Quigley, and you certainly 
have been wonderful to work with and we certainly appreciate 
that. This certainly isn't a shirts versus skins or Republican 
versus Democrat issue. I think trying to understand the depths 
of this problem certainly behooves both the Parties and the 
American people and their right to know. I want to begin, 
before we introduce the panel, we have the mission statement of 
the Oversight Committee, and at the chairman's request, I would 
like to read that for all that are here today:
    We exist to secure two fundamental principles: First 
Americans have the right to know that the money Washington 
takes from them is well spent. And second, Americans deserve an 
efficient effective government that works for them. Our duty on 
the Oversight and Government Reform Committee is to protect 
these rights. Our solemn responsibility is to hold government 
accountable to taxpayers because taxpayers have a right to know 
what they get from their government. We will work tirelessly in 
partnering with citizen watchdogs to deliver the facts to the 
American people and bring genuine reform to the Federal 
bureaucracy.
    This is the mission of the Oversight and Government Reform 
Committee.
    So with that in mind, I would like to introduce today's 
panel. Nicole Gelinas is the Searle Freedom Trust fellow at the 
Manhattan Institute and a contributing editor of City Journal. 
Gelinas writes an urban economics and finance, municipal and 
corporate finance, and business issues. She is a Chartered 
Financial Analyst, charter holder and member of the New York 
Society of Securities Analysts. Her most recent book, ``After 
the Fall: Saving Capitalism from Wall Street--and Washington'' 
was about the financial crisis of 2008 and was published in 
November 2009.
    David Arthur Skeel is the S. Samuel Arsht professor of 
corporate law at the University of Pennsylvania Law School. He 
is the author of ``Icarus in the Boardroom'' published in 2005 
and ``Debt's Dominion: A History of Bankruptcy Law in America'' 
published in 2001, as well as numerous articles and other 
publications.
    Eileen Norcross is a senior research fellow with the Social 
Change Project and the lead researcher on the State and Local 
Public Policy Project. Her work focuses on the questions of how 
societies sustain prosperity and the role civil society plays 
in supporting economic resiliency. Her areas of research 
include fiscal federalism and institutions, State and local 
governments and economic development.
    Iris J. Lav is a senior adviser with the Center on Budget 
and Policy Priorities. Prior to joining the Center, she was 
associate director of public policy for the American Federation 
of State, County and Municipal Employees and senior associate 
at a consulting firm.
    Thank you all for being here today. Members will have 7 
days to submit opening statements for the Record. It is the 
policy of this committee that all witnesses be sworn in before 
they testify.
    Will you please rise and raise your right hands?
    [Witnesses sworn.]
    Mr. McHenry. The record will reflect that all answered in 
the affirmative. Thank you. And we will certainly begin, Ms. 
Gelinas, with you. You will have 5 minutes to give your opening 
statement. At 1 minute remaining, the yellow light will come 
up. If you could summarize your opening statements, everyone 
has that for the Record, and we will begin with you.

  STATEMENTS OF NICOLE GELINAS, SEARLE FREEDOM TRUST FELLOW, 
  MANHATTAN INSTITUTE; PROFESSOR DAVID SKEEL, S. SAMUEL ARSHT 
  PROFESSOR OF CORPORATE LAW, UNIVERSITY OF PENNSYLVANIA LAW 
SCHOOL; EILEEN NORCROSS, SENIOR RESEARCH FELLOW, SOCIAL CHANGE 
 PROJECT AT THE MERCATUS CENTER; AND IRIS LAV, SENIOR ADVISOR, 
             CENTER ON BUDGET AND POLICY PRIORITIES

                  STATEMENT OF NICOLE GELINAS

    Ms. Gelinas. Yes. Good morning, Chairman McHenry, Ranking 
Member Quigley, members of the subcommittee. Thank you for 
inviting me to testify today on this important topic.
    Congress is right to worry about the choice between bailing 
out States and watching as they risk repudiating their long-
term obligations to bond holders and other creditors, including 
union members. The good news is that Congress can still act to 
avoid this difficult choice. The bad news is that a State 
bankruptcy statute is not going to be the answer. Sometimes 
arriving at a solution means eliminating the bad solutions. So 
I will talk for a few moments about why State bankruptcy is not 
the answer and talk for my remaining moments about what are 
some of the answers.
    Proponents of a bankruptcy statute for States say that 
special interests have taken over the State budgeting process, 
that there is no prospect of States getting their long-term 
pension obligations, health care obligations to retirees and 
debt obligations under control absent an external force outside 
the State political process. Proponents believe that this could 
be the external force. In this scenario, States could threaten 
bankruptcy to wring concessions from their creditors, 
particularly labor unions, changing future pension benefits, 
health care benefits, and the like. Bondholders who would be 
worried about this prospect would force States to do this 
before they get into a crisis situation.
    As a practical matter, though, bankruptcy is unlikely to 
help States solve their fiscal problems and actually would add 
new problems. One reason is how States have structured their 
bond obligations. When many people think of money that a State 
owes, they think of a State's general obligation bonds, bonds 
against which the State has pledged its full faith and credit 
to pay back its debt.
    States do not issue only general obligation bonds, though. 
They issue bonds through hundreds of public authorities. New 
York State, for example, owes nearly $80 billion in debt, only 
about $3\1/2\ billion of that is through general obligation 
debt. The remainder is through hundreds of these public 
authorities, special purpose vehicles and so forth. Each of 
these authorities is its own corporation. It is not an agency 
or an arm of the State. It has its own board of directors, its 
own covenants with bondholders, its own legal and contractual 
agreements with not only bondholders, but employees and 
retirees.
    There is no practical way for a State to pool all of this 
debt together in one place along with pension and health care 
obligations handed over to a judge and pare it back, at least 
not without violating thousands of preexisting covenants, 
contracts with bondholders and State laws. And this gets to 
Congressman Quigley's points that the Congressman made in his 
opening statements, changing the rules mid-game would affect 
not only States that have gotten themselves into trouble with 
their own decisions, such as New York, California, Illinois and 
New Jersey, but also States that are not running these long-
term deficits.
    Introducing a bankruptcy statute would force bondholders to 
all States to question the legal regime. It would take many 
months to sort out the uncertainty. During those months, it is 
quite likely that States would have to pay more on their debt.
    Another practical problem with bankruptcy is that States 
are not like corporations where one person can be authorized to 
speak for the State. In a corporate bankruptcy, you have a CEO, 
an agent of the CEO and a small board of directors all speaking 
as one. In a State bankruptcy, hundreds of State lawmakers 
could not give their power to a Governor to speak in one voice. 
If bankruptcy would not eclipse the normal processes of 
democracy, you would still have hundreds of lawmakers speaking 
in different voices before a judge, no way for a judge to 
simply take over this process of democracy solve a State's 
obligations from on high.
    Another problem is that States do not owe pension benefits 
for the most part. States administer pension benefits on behalf 
of local governments, cities, towns and school districts. So 
bankruptcy for the State would not take care of pension 
obligations. Municipalities can do that through changes in 
State law, require changes in State law but municipalities can 
already declare bankruptcy if that is a way for them to deal 
with their pension obligations. So this does not add a benefit 
to municipalities who owe pension and health care benefits.
    What are some of the other solutions that Congress can look 
to to help States and municipalities pare back their benefits? 
One thing is making sure to States that Congress understands 
that States already have the tools to deal with these things 
themselves. States can change their laws that govern pensions. 
States can change their laws that govern contracts, health care 
benefits. They do not need to look to Congress to do this for 
them.
    And with that, I will conclude my opening remarks. Thank 
you.
    Mr. McHenry. Thank you, Ms. Gelinas.
    [The prepared statement of Ms. Gelinas follows:]



    
    Mr. McHenry. Mr. Skeel.

                    STATEMENT OF DAVID SKEEL

    Mr. Skeel. It's a great honor to appear before you, and I'm 
tempted to say everything that Nicole just said, ``not.'' Not 
exactly that. But I will just make one comment at the outset, 
and that is we have lots of experience dealing with complicated 
bankruptcies. So the fact that it is a multitude of entities is 
not news in the bankruptcy context. I'd be happy to address 
questions about that or either of the other issues that were 
just raised if folks are interested.
    Currently, if a State's functional crisis spirals out of 
control, we really only have two options: The first is that a 
State might simply default on some of its obligations, 
declaring itself unable to pay. The second option is for the 
Federal Government to bail out one or more of the States as it 
bailed out financial institutions like Bear Stearns, Fannie 
Mae, Freddie Mac and AIG during the recent financial crisis. I 
believe that both of these alternatives are deeply problematic 
and that Congress should enact a bankruptcy law for the States, 
not as a first resort, but as an absolute last resort in the 
event that everything else fails.
    The claim that we don't need a bankruptcy law for States 
strikes me as a little bit like saying there's no need for a 
fire department because most homeowners have never had fires in 
their houses, if and one starts the homeowner can probably stop 
it before the crisis gets out of control. Each of these things 
is true, but we still need fire departments for the rare case 
when a fire does burn out of control.
    In the remainder of my discussion, I would like to make 
three simple points: First, bankruptcy would provide several 
enormously important benefits that we don't have in the absence 
of bankruptcy. Second, it is constitutionally permissible, in 
case you all are concerned about that, as well you should be. 
Third, the law could be tailored to address any particular 
concerns you might have about things like it being too easy for 
a State to file or there be the bankruptcy law being too harsh 
for particular kinds of constituencies.
    So let me say, to the extent I have time, a brief word 
about each. First the benefits that bankruptcy would provide 
for a troubled State. One of the main benefits bankruptcy would 
provide is a way to restructure some kinds of obligations that 
probably can't be restructured outside of bankruptcy. And I 
would include pensions in that. There are real limits on what 
can be done with pensions outside of bankruptcy. I would 
include bonds in that category as well.
    The other huge benefit of bankruptcy is if it is necessary 
as an absolute last resort, is it brings everybody to the 
table. We don't just have one or two constituencies that get 
singled out to make sacrifices. We get everybody to the table, 
and we ask how can we distribute the sacrifices so that it 
makes sense and we can put our finances on a fiscally 
sustainable course.
    My second point is that bankruptcy is fully constitutional, 
even with respect to States. All that needs to be done there, 
there are genuine State sovereignty concerns, and they need to 
be honored, but they can be honored so long as we make sure the 
bankruptcy law is entirely voluntary, meaning that a State 
couldn't be thrown into bankruptcy against its will, and the 
bankruptcy law would also need to ensure that State decision, 
governmental decisionmaking functions were not interfered with. 
All of these are things we already do with respect to municipal 
bankruptcy.
    My final point is that the law can be tailored to deal with 
any concerns you may have. A lot of the discussion, a lot of 
the criticism of State bankruptcy seems to assume there's only 
one possible State bankruptcy law we can have, and it's going 
to require us to cut everything down to zero. That's not the 
case. If you're worried about States being too anxious to file 
for bankruptcy, that there will be strategic use of bankruptcy, 
I think that is a not really a serious worry. But if you are 
worried about it, all you have to do is put some entrants 
requirements on bankruptcy. We already do this with municipal 
bankruptcy.
    If you're worried about the bond markets, you're worried 
the bond markets are going to be concerned because they're 
afraid that bonds are going to be written down to zero, you put 
restrictions as a prerequisite to doing anything with bonds.
    So the final point is simply that we can tailor the 
bankruptcy law to address any concern we may have. My bottom 
line is bankruptcy is not a perfect solution. It would be 
messy. It is an absolute last resort, but it's better than the 
other last resorts which are States simply defaulting on their 
obligations or a Federal bailout.
    Mr. McHenry. Thank you, Mr. Skeel.
    [The prepared statement of Mr. Skeel follows:]



    
    Mr. McHenry. Ms. Norcross.

                  STATEMENT OF EILEEN NORCROSS

    Ms. Norcross. Chairman McHenry, Ranking Member Quigley, and 
members of the subcommittee, thank you for inviting me to 
testify today on this important topic. The recent recession 
exposed several longstanding problems in State budgets that, if 
left unaddressed, the underlying causes for these short-term 
budget gaps, including public sector pension benefits and the 
rising cost of health care, are certain to worsen States' 
prospects for stability and economic growth. But with reform 
today, States can mitigate the worst while meeting their 
promises to employees and taxpayers.
    The recent downturn is only one cause for recent State 
budget gaps. State and local spending has grown faster than 
States' own source revenues and the private economy over the 
past several decades. The fastest growing area of State budgets 
is Medicaid. States have avoided showing deficits in part due 
to Federal funds, and an increasing reliance on debt finance, 
and in some cases, by deferring their contributions to pension 
systems, not funding health care benefits or borrowing to make 
pension payments. These techniques help States show balance, 
grow spending and pass the costs on to the future.
    Without any changes, GAO anticipates State and local 
governments will require an annual and sustained reduction in 
spending of 12.3 percent or an equivalent increase in revenues 
between 2009 and 2058, to close a projected $9.9 trillion 
fiscal gap.
    In addition, State and local governments face a large 
funding gap in their pension systems. Governments report the 
unfunded liability for State and local pensions at $1 trillion 
but economists estimate it closer to $3\1/2\ trillion.
    According to government accounting standards, the discount 
rate used to value plan liabilities may be based on what the 
assets are expected to return when invested, an average of 8 
percent annually. This violates economic theory which says the 
value of the liability is independent from how it is financed. 
Choosing the discount rate requires matching that rate with 
what's being valued, in this case, a public sector pension 
which is safe, government guaranteed and thus should be matched 
with a rate that reflects that safety, such as the yield on 
Treasury bonds, currently at 4 percent.
    The circular logic of government pension accounting 
standards has had several consequences for pension funding. It 
has lead to the undervaluing of pension promises and amount 
necessary to be set aside to fund the promise, plans have been 
encouraged to embrace more investment risk, including 
increasing their risk exposure after the recent market downturn 
to make up for losses.
    Union leaders and politicians in negotiations in the 1990's 
when the market was booming, often boosted benefit formulas 
because plans looked overvalued on paper. Governments have 
also, as mentioned, deferred payments to the system and issued 
bonds.
    When are plans likely to run out of assets? Economist 
Joshua Rauh of Northwestern University estimates under the 
generous assumption, the State's own assumption, of an 8 
percent annual return on pension assets that by decade's end, 
eight States will run out of assets to pay their beneficiaries. 
Illinois will require $11 billion annually beginning to 2019 in 
this scenario. New Jersey will require $10 billion annually in 
2021.
    A less dire scenario is offered by the Center for 
Retirement Research at Boston College to remain funded by 2014, 
Illinois will require 13 percent of its budget to ensure fund 
solvency, New Jersey will require 12\1/2\ percent of its 
budget. This requires choices these States have, to date, have 
avoided making. Other economists and actuaries have reduced 
equally dire scenarios as Dr. Rauh. But ultimately I stress it 
is incumbent upon State Governors and treasurers to ask 
actuaries to stress test their pension systems under a range of 
assumptions.
    I believe the biggest impact the Federal Government can 
have in helping the States is in the area of Medicaid reform 
and mandate relief. For State pensions, I have two 
recommendations, first, transparent and accurate accounting. 
Governments must stress test their pension systems and model 
the cash-flows to determine what will be needed to set aside to 
pay these promises. These scenarios should include the risk 
free discount rate as recommended by economists. The data, 
method and assumptions should be made available to the public.
    Second, stabilize public sector pension systems, to pay 
what has been promised by minimizing the burden on taxpayers, 
States should consider freezing and reducing the cost of living 
adjustment in current defined benefit plans, increasing the 
retirement age, increasing contributions from workers and 
importantly close the defined benefit plan and move workers to 
defined contribution plan.
    The last reform will allow workers more flexibility, shift 
risk away from taxpayers and end the political and fiscal 
manipulation of worker benefits which has turned what was 
supposed to be a safe investment for public sector workers into 
a gamble for both employees and taxpayers. Accurate accounting 
will enable States to know the tradeoffs necessary today and 
delay will only ensure what is a big problem turns into a 
crisis by decade's end. Thank you. I look forward to your 
questions.
    Mr. McHenry. Thank you, Ms. Norcross.
    [The prepared statement of Ms. Norcross follows:]



    
    Mr. McHenry. Mrs. Lav.

                     STATEMENT OF IRIS LAV

    Ms. Lav. Mr. Chairman, Mr. Quigley, members of the 
subcommittee, thank you for the invitation to appear before you 
today. I believe that predictions that States throughout the 
country will have to bail out localities or that the Federal 
Government will have to bail out the States are substantially 
exaggerated, and I think they are producing unnecessary alarm 
among policymakers and the public at large.
    I would like to untangle some of these claims today about 
cyclical issues, bonds and pensions.
    First, cyclical issues. States are projecting large 
operating deficits as you said of about $125 billion for the 
2012 fiscal year, which begins in July in most States. 
Unemployment remains high. Revenues remain below pre-recession 
levels, and there is rising demand for public services due to 
the weak economy and growing population. Figure one please. 
Moreover, the fiscal relief provided through the American 
Recovery and Reinvestment Act in 2009 is ending. That's not 
mine. That's someone else's.
    It has been enormously helpful in allowing States to avert 
potential budget cuts and tax increases. States have used the 
fiscal relief to cover about one-third of their budget 
shortfalls through the current fiscal year, but only about $6 
billion will be available for next year, covering less than 5 
percent of these shortfalls.
    As difficult and painful as the choices are, States and 
localities will balance their upcoming budgets through budget 
cuts, tax increases and use of reserve funds. That's what they 
do. And remember, it's a cyclical problem that will shrink in 
size as the economy continues to recover and State revenues 
continue to grow.
    Second, bond. So there's no credible evidence of a bubble 
or crisis in State and local bonds.
    If we could go to figure 3 please.
    First interest payments on State and local bonds absorb 
just 4 to 5 percent of current State and local expenditures, no 
more than they did in the 1970's. And the historical default 
rates since 1970, through several recessions, has been about 
one-third of 1 percent.
    Finally, there's no large increase in bond issuance nor are 
their exotic securities that hide the underlying value of the 
assets against which the bonds are issued, as was the case with 
the subprime mortgage bonds.
    Third, pensions, which, of course, is a little more 
complicated. There are shortfalls, we all said, in pension 
funding for future State and local retirees. States will have 
to address them over the next three decades or so.
    Figure 4 please.
    Pensions were fully funded in 2000 before the last two 
recessions using standard accounting. The recessions reduced 
the value of assets and some jurisdictions didn't make the 
required deposits. So as was mentioned, the Center for 
Retirement Research at Boston College finds that States and 
localities have about $700 billion in unfunded liabilities. 
That implies they have to increase their contributions on 
average over the next 30 years from about 3.8 percent of 
budgets to 5 percent of budgets. Now that's on average, it's 
not Illinois. But changes to pension plans could reduce that 
cost, and 3.8 percent to 5 percent is not a crisis.
    The major controversy is over whether these traditional 
accounting standards are appropriate. And that $3 trillion 
number which comes from economists who measure future costs 
assuming a riskless rate of returning such as in Treasury bonds 
about 4 percent.
    Figure 5 please.
    But pension funds do invest in a diversified basket of 
private securities. The average historical rate of return has 
been about 8 percent, as you can see in that chart. It may or 
may not be a little lower going forward, but it's quite 
unlikely to be just 4 percent. So the $3 trillion numbers of 
construct doesn't represent the amount that pension funds have 
to invest to meet their obligations. The States in trouble are 
basically those that skipped their payments.
    To summarize, cyclical problems are serious but will abate 
as the economy improves. The muni bond market is not in a 
bubble or in danger of experiencing widespread default, and 
pensions need attention but in most cases are not in crisis.
    I see no need for Federal intervention in these areas. 
States do not want or need the power to declare bankruptcy. Nor 
is there a need, as Mr. Nunes has suggested, for Federal 
legislation to require States and localities to report their 
pensions on a riskless rate as a condition for issuing tax 
exempt bonds. And I should note there's a process going on in 
the Governmental Accounting Standards Board to reform already 
going on 2 years to reform the way pensions are reported and to 
put all States reporting on the same basis which would be a 
transparency improvement, so you could see what's going on and 
to have a reasonable actuarial method for reporting and Mr. 
Nunes's proposal would short-circuit that. Thank you.
    Mr. McHenry. Thank you, Ms. Lav. I certainly appreciate 
that.
    [The prepared statement of Ms. Lav follows:]



    
    Mr. McHenry. And we will begin the questioning with the 
vice chair of the subcommittee, Mr. Guinta of New Hampshire.
    Mr. Guinta. Thank you very much, Mr. Chairman, and thank 
each of you for coming and testifying before us today. I have a 
couple questions for each of you so I'm going to try to be 
quick. First with Ms. Lav. You had stated that there is no 
impending or looming crisis at the moment. I guess the first 
question I would have is how would you define a crisis if what 
we are seeing with the States and their obligation requirements 
at the levels they are at? How would you define a crisis?
    Ms. Lav. I would define a crisis as something States had no 
way of digging themselves out of. States have many, many tools 
in which to do this. So if you have to raise your pension 
contributions from 3.8 percent of expenditures to 5 percent of 
expenditures, that's probably, you can accommodate that within 
budget particularly after the economy recovers. And certainly, 
they are cyclical deficits. States are finding ways to close 
those cyclical deficits. We don't appreciate some of a lot of 
the budget cuts States are making which are harming low income 
people and residents, but that's what they do. States have 
balanced budget requirements and that's what they do. They 
manage their finances.
    Mr. Guinta. I think the concern that I and others share is 
that as States ``manage their finances'' they are spending an 
extraordinarily higher amount of money percentagewise of 
borrowed dollars to get us through these ``lean or 
challenging'' economic times.
    My State of New Hampshire has done that to pay expenses, 
New Jersey has done that to pay expenses, which is not either 
good GASB accounting standard practices, or it is just not good 
business standards of practice. And I don't know that you had a 
chance to touch upon it in your verbal remarks, but I note that 
in your written remarks, you talked about the GASB standards. 
My concern is, at some point, there is this potential of States 
wanting to come to the Federal Government for a ``bailout'' 
because of what they define as an economic challenge that 
they're having.
    I would argue something a little bit different. Any 
responsible Governor, legislature or administrator should be 
anticipating these challenges, and it doesn't appear that has 
been done in a responsible way.
    So I understand your point. But can you speak to those 
States that are borrowing money essentially to pay for ongoing 
expenses? And I'm not even talking about stimulus money they 
have received. I'm just talking about borrowing money.
    Ms. Lav. Very few States borrow for operating expenses. 
Illinois has borrowed a number of times, floated bonds to make 
its pension contributions, which is very bad practice.
    By and large, States borrow money for infrastructure, and 
you don't see in the data any substantial run-up in borrowing 
as a percent of gross State product. We have a chart there that 
I provided some information to you behind my testimony some 
graphics and State-by-State information on that. You don't 
really see any run-up in borrowing. It isn't good practice for 
States to borrow to pay their operating expenses. They should 
borrow for infrastructure, because that is what makes sense to 
do economically. So we don't approve of borrowing for operating 
expenses usually. And in the longer paper that I refer to in my 
written testimony, we do have, the whole last section does 
suggest that States do have, as I believe Mr. Quigley referred 
to in Illinois, some structural deficits and mismatch between 
their expenditures and their revenues and part of that, and 
they do need to take some steps to fix those mismatches. There 
is no question about that. But a lot of that mismatch comes 
from the rate of growth of health care costs in the economy. 
States spend a lot of their money on health care, and health 
care costs are growing faster than the economy, all throughout 
the economy in the private sector and in the public sector and 
so States which have revenues that very often go somewhat 
slower than the economy because of the structure of their tax 
system have a very hard time meeting their responsibilities to 
provide health care to those people in the States that need it, 
the elderly and the disabled and the poor.
    Mr. Guinta. I would agree that States need to better manage 
the pie in the budgetary challenges they are having. But it 
sounds like you are making an argument now for bankruptcy when 
in your comments, you suggest that it's not necessary at this 
point because of the looming fiscal challenges that they're 
having.
    Ms. Lav. They don't need bankruptcy to fix these problems.
    Mr. Guinta. I do want to ask Ms. Norcross if you would be 
able to comment a little bit on the testimony we just heard.
    Ms. Norcross. I would like to explain the discount rate 
controversy a little more than by way of analogy and it's 
important because it has informed decades of policy within the 
pensions systems, which I believe we are seeing the results of 
that today. And the analogy is this, the reason you can't 
choose a discount rate based on what you think your assets will 
return to value the liability is, if you consider you have a 
mortgage and you have, let's say, a mutual fund, your broker 
says, we think, I think you're going to return 10 percent 
annually on your mutual fund. That doesn't enable you to slice 
your mortgage in half. The bank doesn't send you a different 
mortgage statement based on that.
    So what that circular logic has produced over the years and 
certainly, yeah, in the 1980's and the 1990's some of these 
pension plans looked fine, A, they have undervalued the size of 
the promise so they're sort of expecting that rate of return 
will be taking care of the necessary contributions that they 
should be making to fund the system.
    And No. 2, when plans look overfunded on paper, it led some 
States to grant these really generous benefit enhancements 
without even doing the math. In New Jersey, in 2001, the State 
granted a 9 percent benefit increase and didn't even figure out 
what it would cost them. And that's one of the areas the 
Governor is trying to address right now.
    And remarkably, it violates another principle, which is you 
can secure a guaranteed investment with a high risk stream of 
investments, and in the short term, you're going to realize 
more volatility in your investments, and yet that promise is 
due within 15 years.
    So they're basically trying to secure a guaranteed pay-out 
with a high-risk investment, and that is the flaw of logic. But 
Joshua Rauh, in his paper, he uses the 8 percent discount rate. 
And he says even that, even if we grant you that, we're looking 
at funds starting to run out of assets with 3 percent revenue 
growth by the end of the decade. New Jersey's actuaries also 
released a paper on their new reports on Friday using the 8.25 
discount rate and they say we have 12 years in the police 
officer's plan. So I hope those comments help.
    Mr. McHenry. I thank you for your testimony. The 
gentleman's time has expired. At the request of the 
subcommittee ranking member he is deferred to the full 
committee ranking member.
    Mr. Cummings, you are recognized for 5 minutes.
    Mr. Cummings. Thank you very much, Mr. Chairman. I want to 
thank you and our ranking member, and I thank you for working 
in a bipartisan way to address this problem.
    Ms. Lav, it is interesting after listening to the vice 
chairman of our subcommittee speaking just a moment ago, I find 
it interesting that the National Governors Association, that 
is, Republican and Democratic Governors through their chairmen 
and vice chairmen, said this on February 4, 2011: ``Allowing 
States to declare bankruptcy is not an authority any State 
leader has asked for nor would they likely use. States are 
sovereign entities in which the public trust is granted to its 
elected leaders. The reported bankruptcy proposal suggests that 
a bankruptcy court is better able to overcome political 
differences, restore fiscal stability and manage the finances 
of a State. These assertions are false and serve only to 
threaten the fabric of the State and local finance.''
    Ms. Lav do you agree with these Governors that the State 
bankruptcy proposal threatens the fabric, and these are their 
words of State and local finance? Can you be brief please? I 
have several questions.
    Ms. Lav. Yes, I do agree. States have all the tools they 
need to manage their finances. Occasionally, one State doesn't, 
but they have the tools they need.
    Mr. Cummings. And what would you recommend as to how those 
States might improve their fiscal situations?
    Ms. Lav. I think there are many ways that States can 
improve their fiscal situations. They can move to taking a 
longer term look, many of them only look 1 year ahead or 2 
years ahead. They can improve their revenue systems and be sure 
their revenues match with their expenditures. They can have 
processes in place where there are consequences of skipping a 
pension contribution, which has caused a lot of the problems we 
are talking about today.
    There are many things that they can do to make it clearer 
to policymakers and the public about their own situations and 
allow some oversight. But I think that States themselves have 
the ability to do that, and that this recession has just been 
so very long and so very deep that some of the flaws have 
become apparent, but it's not going to be forever, and I think 
they will adjust their revenues and their expenditures to 
manage these problems.
    Mr. Cummings. Our House Budget Committee chair, Paul Ryan 
and the Republicans proposed cutting the Federal budget 
domestic discretionary non-military non-security spending 
approximately $40 billion this year and much more in the 
future. Wouldn't this significantly worsen the State and local 
governments' fiscal problems because a lot of that money flows 
to the State, is that right?
    Ms. Lav. Yes. That's right.
    Mr. Cummings. And this is no gift is it? It's not a gift to 
the States?
    Ms. Lav. No. It's not a gift. It's a penalty for the States 
basically. It is about a third of non-security spending that 
Mr. Ryan wants to cut is our grants that flow through to State 
and local governments, and so depending we don't have the exact 
number, but somewhere probably between about, don't hold me 
exactly to it, but $10 and $13 billion would be money that the 
States would have to scramble on top of their existing 
deficits, additional deficits they would have to close because 
of these cuts.
    Mr. Cummings. Isn't most underfunding of State pensions due 
to recent dramatic declines in the stock market which hurt 
investment portfolios of almost all American investors 
including hedge funds, regular working people, and probably 
most lawmakers and staff, reporters and attendees here today, 
given the recent emerging recovery market up turn and projected 
future gains, don't you agree with the analysis expecting 
future long-term gains equally over the next 30 years to smooth 
out today's current problems?
    And the reason why I raise this, and any of you all can 
answer this, is that when the storm is over, I don't want to 
see situations where our employees, by the way a lot of them 
are working in this room today, may have lost their pensions 
and now going to the States, State pensions have been 
diminished, States come out of recovery, and then because some 
States fail to make their pension payments on time, and you got 
to keep in mind the employees, they pay, they have to pay, 
right? They have to pay.
    Ms. Lav. Yes. The contributions come in on time.
    Mr. Cummings. So one of my concerns is when the storm is 
over, then these folks have been locked out of a lot of money 
that they were due. So I will start with you, Ms. Lav, and then 
maybe some of the others may have a comment on that.
    Ms. Lav. Of course the improvement in the economy and the 
improvement in the market will have a lot to do with improving 
the outlook of pensions over time, and for most States, that 
have not provided retroactive benefits without funding them or 
have not seen a pension payment contributions in the past, they 
will be fine. So the vast majority of States will be fine when 
that occurs, as that occurs.
    Ms. Norcross. I would say that the only reason why workers 
may lose some of the benefits that are promised is because the 
investments have been treated as a gamble rather than secured 
as they should have been secured. They've been misvalued and 
therefore the investment strategies have not been appropriate 
for the plan. I share the view that what's been promised has 
been promised, and that people have worked for this and they 
have contributed for it. I also caution, and as Ms. Lav 
mentioned, every State pension system and every local pension 
system has a little bit something different going on. We know 
about the worst funded plans.
    But I would caution that Josh Rauh's paper is extremely 
important because again he is saying OK, I grant you 8 percent 
returns and he shows you a time table of when if there is no 
change to policies, these plans can expect to run out of 
assets.
    Mr. McHenry. Thank you, Ms. Norcross. The gentleman's time 
has expired.
    Mr. Cummings. Thank you very much, Mr. Chairman.
    Mr. McHenry. Thank you. I certainly appreciate that. And if 
I could call up slide No. 1. This is a representation of the 
difference between inflation, the 1950 baseline, the 
difference, the blue line would be private spending increases 
since 1950 to now versus State and local government spending 
increases in the red line. Private spending has increased 5 
times, but local and State government spending has increased 10 
times. So it's not a question of a funding shortfall, it's a 
spending problem. Would you concur with that Ms. Norcross?
    Ms. Norcross. I would say that's a big part of it yes.
    Mr. McHenry. Now in terms of the discussion about public 
pensions, understanding the magnitude of the problem is one 
thing we want to understand here today, if it is knowable. Ms. 
Gelinas, you mention in your testimony a funding shortfall. Is 
there a range, is there an agreement on what the funding 
shortfall is for public pensions?
    Ms. Gelinas. Thank you, Chairman. There's not an agreement, 
a rough range would be $700 billion to $3 trillion as you can 
see, that's a large range. This involves predicting things that 
are very difficult, really impossible to predict. You have to 
predict the performance not only of the U.S. stock market, but 
of global equity and bond markets. You have to predict the 
course of future inflation and also predict how long people and 
their survivors are going to live.
    Mr. McHenry. Ms. Norcross, do you concur with that range?
    Ms. Norcross. Yes, well, under a range of assumptions yes.
    Mr. McHenry. What would----
    Ms. Norcross. Meaning the $700 billion would be under the 
current assumptions of the 8 percent discount rate range. 
That's why advocating for stress testing the pensions and 
granting economists how they would value the plan.
    Mr. McHenry. What is the upward end?
    Ms. Norcross. $3\1/2\ trillion.
    Mr. McHenry. OK. Now, to this point, Ms. Gelinas, is there 
a--under current government accounting standards, is it 
sufficient? Do we have enough transparency in understanding the 
unfunded liabilities of these State and local government 
pensions?
    Ms. Gelinas. No, it's not sufficient. I would advocate 
asking the States and large municipalities to report the 
assumptions--report the liabilities under a range of 
assumptions. Report it under a lower what used to be called a 
risk free rate, maybe 3 percent annual return, report it under 
the 8 percent return if they like to continue to do that and 
allow investors to make up their mind.
    I don't think there's a big--there's a problem with 
disclosure, but it is not the biggest problem because investors 
can do their own calculations on these liabilities. We've seen 
Dr. Rauh and others do it on their own. If the investors do not 
like what is reported, they can simply not invest in the debt.
    So again, we should have more disclosure. But the problem 
is not that we don't understand the magnitude of the issue. It 
is getting the political will within States to change State 
constitutions which govern pension benefits for future workers, 
people who have not been hired, change State laws governing 
collective bargaining, wages, health care and so forth.
    Mr. McHenry. Would you concur with that Ms. Norcross?
    Ms. Norcross. I agree.
    Mr. McHenry. That's simple enough. That's reasonable.
    Are the government accounting standards for pensions 
similar or dissimilar to what public companies are required to 
disclose? Ms. Norcross.
    Ms. Norcross. They're a little bit different in private 
sector defined benefit plans, they do use something closer to a 
risk free rate, and they're valuable but different than the 
public sector plans.
    Mr. McHenry. Ms. Gelinas, would you like to add anything to 
that?
    Ms. Gelinas. No.
    Mr. McHenry. Wow. Going pretty smoothly. So in terms of, 
Ms. Norcross, in your testimony, you discuss that State 
spending grew faster than States' own revenue sources in 47 
States from 1977 to 2007. And to this point, can you explain 
the danger of States reporting budgetary imbalances when they 
are actually using Federal funds and debt to fund these 
expenditures?
    Ms. Norcross. I think that just highlights the pie and 
what's in the pie, so you have States' own source revenue, you 
have Federal funds debt and other, and a deficit if you're just 
considering what a State can support on its own, that can be 
papered over if you then sort of discount that they're getting 
Federal funds which can stimulate sometimes greater spending or 
cause a State to need to raise taxes to support that spending 
and also the rising use of debt.
    And I agree that debt is not a very large portion of 
budgets, we've seen some techniques recently where States will 
bond, they'll dump a trust fund bond to replace it and use that 
to balance the budget. So maybe they're not bonding directly 
for operating expenses, but they are.
    Mr. McHenry. To that point, have States changed the nature 
of what they use bonds for? The nature of rather than building 
a road, are they changing it to plug a pension fund promise, 
has that changed?
    Ms. Norcross. We've seen more bonding for stuff like that. 
Also the definition of capital can be pretty flexible.
    Mr. McHenry. Thank you for your testimony. My time has 
expired. And now Mr. Quigley, the ranking member, is recognized 
for 5 minutes.
    Mr. Quigley. Thank you, Mr. Chairman.
    So far the problems that we have seen with these States, 
these 8 or 10 States that are in particular trouble, seem to be 
self-contained. I would like to ask any one of you, if you can, 
what the potential systemic risk are. I guess if the last 
economic crisis taught us anything is that everything is 
interconnected. In terms of the market or what have you, if 
there is a big hiccup, and there certainly are threats with 
some of these States, defaulting or having some other problem, 
missing payments and so forth, the impact on other States, the 
impact on bond ratings, but also the bond market itself. So 
while there may be only 8 to 10 States, that is 25 percent of 
the country's population. What are the impacts on the rest of 
the States?
    Mr. Skeel. I will jump in on that really quickly. I think 
the risk of contagion is much less severe than it was in 2008 
with the financial institutions. I think the bond markets know 
the difference between the States that are in real trouble and 
the States that are not.
    Mr. Quigley. Do you think their investors do?
    Mr. Skeel. I do. I do.
    I think we have to have some confidence in the ability of 
the markets to make those distinctions. That is my first point.
    My second point would be that a lot of the problems with 
the financial institutions was hot money. It was that they 
depended really heavily on short term financing which was 
subject to immediate withdrawal. States are not subject to 
financing that is going to disappear instantly. They have tax 
revenues coming in. They are likely to be able to continue 
borrowing. So I think it is a very different kind of crisis.
    Ms. Lav. It is possible to panic markets in the short term. 
Meredith Whitney has succeeded in doing that in the municipal 
bond markets by claiming----
    Mr. Quigley. That is the first time the name was mentioned 
today.
    Mr. Skeel. You violated our rule.
    Ms. Lav. Sorry about that. But in the long run, people 
realize what the fundamentals are and you can see that there is 
beginning to be some improvements in that markets now that her 
comments have been put to rest.
    So I think that there are distinctions among States. You 
know, the last time a State defaulted was in the Great 
Depression, and even in the Great Depression, only one State, 
Arkansas, defaulted. Only four cities or counties have actually 
defaulted since 1970. We are talking, you know, I don't think 
we are going to have a major default crisis. I think that there 
will be ways. You are going to have some sewer districts and 
some revenues bonds that were tied to the housing bubble and so 
forth that are going to have trouble paying, and those 
districts are going to have some problems, and the States will 
probably step in, as Pennsylvania stepped in in Harrisburg, and 
sort that out in a reasonable way. I just cannot see a scenario 
of major default and contagion.
    Ms. Gelinas. If I may add to that, I would say one issue 
that risks courting a bond market crisis would be changing the 
statute to allow for Federal bankruptcy because if I am a bond 
holder, and for example, take New York's Metropolitan 
Transportation Authority, an entity with $30 billion worth of 
debt, I have lent money to this entity based on a long list of 
covenants, including a State law that says that for as long as 
these bonds are outstanding, this entity will not declare 
bankruptcy.
    That is what New York lawmakers have determined under the 
democratic process. If there is any question that you have a 
new Federal statute that would somehow supersede that, or this 
idea that you could take away promises made to these 
bondholders to give to bondholders or unions at another State 
entity, this risk would take many months to sort out.
    I would also add maybe not the potential for an acute 
crisis that we saw in September 2008, but the potential for the 
risk of losses at banks where you don't need a default for the 
market value of these securities to decline. You've got more 
than $200 billion of municipal debt in banks, similar amounts 
in money markets and insurance funds. If banks worry that the 
value of these securities have declined, they may pull back on 
lending to the rest of the economy, again, not a crisis or 
panic, but makes the recovery more difficult. The question is 
what are you getting for making it more difficult. You are not 
getting much benefit because States have the tools to fix these 
problems.
    Mr. Skeel. I would just add one brief response, and that 
is, this is all assuming that the States wouldn't default on 
these bonds. I think the question we have to ask is what are 
the possibilities? One possibility is no bankruptcy, they 
simply default completely.
    Mr. Quigley. Let me ask one other question to Ms. Norcross. 
You talk about the rate of return and you advocate to reducing 
it to what you judge is a much more realistic figure. The same 
sort of question, a quick shift from perhaps 8.25 to 8.4 would 
have to have some sort of impact, pretty traumatic obviously 
from a fiscal point of view and how much the contributions 
would have to be increased, but also within, again, the market 
that looks at this, would you see this being done through a 
slower period of time, an adjustment period, or how would you 
see that work?
    Ms. Norcross. Well, I agree with what Ms. Gelinas said, you 
should probably grant a range of assumptions. But the liability 
is the liability. So simply targeting a rate that makes it look 
a little bit better, it only masks over the underlying reality 
of what is owed. Also, if you're going to pay this out over 15 
years, my concern is that in cases like Illinois where they are 
going to take on more risk in their investment strategy to make 
up for what was lost. So that is why I would caution you.
    Mr. McHenry. I thank the ranking member.
    Mrs. Maloney of New York is recognized for 5 minutes.
    Mrs. Maloney. I thank the chairman and ranking member for 
organizing this important hearing and all of the panelists for 
their thoughtful testimony.
    I would like to gain a deeper understanding of the 
magnitude of the challenge. I would first like to ask Ms. 
Norcross and Ms. Lav to qualify and expand on a statement in 
Ms. Lav's testimony where you stated that States and localities 
devote 3.8 percent of their operating budgets to pension 
funding. First, I would like to know where you got this number 
from, and is this an accepted number universally. And if that, 
in fact, is the correct number, based on this number, how can 
you suggest that public pension costs are the large costs of 
the State and local financial problems. As we know, we are just 
digging our way out from the great recession that has impacted 
our entire country and there are many costs there. Could you 
comment first, Ms. Norcross, and then Ms. Lav.
    Ms. Norcross. I believe Ms. Lav gets that figure from the 
Alicia Munnell paper, and that is what her estimate is on what 
States have been contributing on average. So that would be all 
plans. She estimates if you use the 8 percent discount rate, 
you would have to raise that to 5 percent of budget on average.
    Ms. Lav. That is correct, we worked with the Boston College 
people, Alicia Munnell, using our expertise on State and local 
finance to help them come up with that figure.
    Mrs. Maloney. So how can you suggest that this is the cause 
of the local and State financial problems if the contribution 
is just 3.8 percent?
    Ms. Lav. It isn't. It isn't the cause. Pension 
contributions come from general funds. And the big deficit 
number is $125 billion that you are hearing about, is a general 
fund number. But pension contributions, neither pension 
contributions nor interest on bonds are the major component of 
that. The major component of the deficits is the expenditure 
States have--Medicaid, health care and education and so forth. 
So that is why I said it is not a crisis to raise from 3.8 
percent to 5 percent in the way that the State budgets, the 
State and local budgets are put together. You can do that over 
time. It is not a big crisis.
    You know, all of this talk about the riskless rate, that is 
one way to look at it. The Munnell paper says you have to go to 
9 percent which would be a big problem if you use the riskless 
rate. But there is a distinction between valuing the 
liabilities and how much you have to deposit to make the 
pension whole. I would say that those are two different things.
    Mrs. Maloney. Well, on the riskless rate that a number of 
you testified on, I would like some clarification from it. Is 
it true that this rate is different from what the private 
sector pension plans use? Is it different?
    Ms. Norcross. Private sector pension plans admit they have 
a little more risk because the company can go bankrupt. They 
use the corporate bond rate to reflect the risk.
    Ms. Lav. It is higher than the riskless rate. The corporate 
bond rate is, I don't know, 5\1/2\ percent, 6 percent, that 
they use.
    Mrs. Maloney. Why should there be a different rate for 
public pensions and private pensions?
    Ms. Lav. Well, because private pensions have to be a little 
more conservative because a private company can go out of 
business and then they dump their liabilities for their 
pensions on the Public Benefit Guaranty Corp. So ERISA, so the 
Federal Government, doesn't have to bail out the private 
corporation and pay those pension liabilities, insists that it 
uses a more conservative rate. But a public entity is not going 
out of business, and the public entity has taxing power and can 
adjust its taxes and expenditures. It is going to be an ongoing 
entity. You know, there have been GAO reports and other 
observers, most people who look at this say you do not need as 
stringent standards for a public entity as you do for a 
private.
    Mrs. Maloney. So would the riskless rate increase the 
perceived pension shortfall?
    Ms. Lav. Yes, substantially.
    Mrs. Maloney. How does it increase it?
    Ms. Lav. Well, 60 percent of pension assets come from 
return on assets, from investment income. So if you are going 
to say you only are going to get 4 percent on that investment 
income, and you are projecting that 30 years into the future, 
you make up a much larger hole that you have to fill. But if 
you say you are going to get 4 percent and you continue to 
invest in equities, you are saying something that is not true. 
And you are sort of saying you have to overfund the pension in 
the front end because you are saying it is only going to be 4 
percent, but if you get 7 or 8 percent, you are actually going 
to have more in it. That will be, I hate to say it, but it 
could end up with even more temptation for an overfilled 
pension fund to not have consistent contributions every year.
    It is much more realistic to say what you are going to gain 
and consistently contribute the amount you need rather than 
having the feast or famine.
    Mrs. Maloney. My time has expired, but would anyone else 
like to comment?
    Ms. Norcross. I would just like to add, if I may, the logic 
behind that discount rate has again to do with the safety or 
risk of what you are valuing. And so a private sector plan 
reflects some of the risk involved that a company can go out of 
business; whereas the government is guaranteeing 100 percent 
saying you are going to get paid.
    Again, the long time horizon gets back to the idea you have 
15 years in which the majority of your obligations come due, 
and you are securing that with high volatile investments where 
you are lessening the likelihood that the money will be 
available to pay it out.
    Ms. Gelinas. If I can comment as to the magnitude of 
pension liabilities, the reason they don't show up as much at 
the State level is because these are the responsibility often 
of the local governments. They are set by State law but paid by 
the locality. For example, New York City will pay about $8\1/2\ 
billion in pension obligations this year. That is more than 10 
percent of the entire budget, including Federal funding for the 
city. So it is a much bigger problem at the local level than 
the State level.
    Ms. Lav. My figures were State and local.
    Mr. McHenry. Thank you.
    Mr. Quigley is recognized for a unanimous consent request.
    Mr. Quigley. Mr. Chairman, I ask unanimous consent to enter 
into the record a statement from the Governor of the State of 
Massachusetts.
    Mr. McHenry. Without objection, so ordered.
    Mr. Cooper is recognized for 5 minutes.
    Mr. Cooper. Mr. Chairman, I would like to ask unanimous 
consent to insert into the record an article by Jeb Bush and 
Newt Gingrich in the Los Angeles Times entitled ``Better Off 
Bankrupt.''
    Mr. McHenry. Without objection.
    Mr. Cooper. I think in finance hearings, it is really 
important to keep things simple. To my understanding, almost 80 
percent of municipal bonds are owned by individuals in some 
form; is that your understanding? These are more widely held?
    Ms. Lav. The tax exempt bonds, yes. I'm not sure about the 
others.
    Mr. Cooper. Yes, the tax-exempt bonds.
    And what most investors hate is a nasty surprise, a down 
side surprise. So in markets that function well and you have 
transparency, you have a heads-up on oncoming bad news, people 
are usually less alarmed. I want to ask a couple of questions 
about the transparency of these markets.
    What are we missing today comparing these obligations 
between States that would enable an investor, an individual 
investor, to better evaluate these investments? It is my 
understanding that some of these get packaged up in bond funds 
and they just want a tax break. That is the way they diversify 
their risk, but you don't want that bond fund to be harmed 
either. What are we missing in terms of transparency between 
the States?
    Ms. Lav. With respect to bonds, I don't think there is 
anything missing. I think the bond raters have a great deal of 
information about the States and the financial analysts, and 
follow them very closely. So I'm not aware of anybody 
complaining about the transparency of bonds among the States. 
Moody's just put out a new kind of analysis where they added 
together the outstanding bond debt and the pension obligations 
so you could look at it in one place. I think that is a good 
thing.
    With respect to pension obligations, I think there is a 
problem of not being able to look at State-by-State pensions on 
the same basis.
    Mr. Cooper. Exactly what are those problems?
    Ms. Lav. They use different standards. There are a range of 
actuarial standards and it is pretty arcane as to how you 
measure future liabilities and so forth. And States can choose 
which ones they want.
    I mentioned at the beginning of this hearing that the 
Governmental Accounting Standards Board is very close to 
issuing a new standard that no longer will allow that and that 
will require----
    Mr. Cooper. Then after GASB has a new standard, we will 
have an apples-to-apples comparison between the States?
    Ms. Lav. I believe so, yes.
    Mr. Cooper. On pension obligations?
    Ms. Lav. Yes.
    Mr. Cooper. Do all the panelists agree with that?
    Ms. Norcross. I believe that is so.
    Mr. Cooper. So this is pending, it is about to happen, it 
doesn't require legislation?
    Ms. Norcross. If I might clarify, is that a rule that is 
going to require them to use the ABO versus the PBO, or are you 
referring to GASB 25? Because GASB is also working on the 
discount rate rule, but I don't think that they have solved 
that problem.
    Ms. Lav. Yes, they are looking both together.
    Mr. Cooper. So in the next few months, we will have greater 
comparability between the States so an investor, an individual 
investor, can evaluate the risk involved in the most complex 
aspect of this which is valuing pension obligations?
    Ms. Lav. That is my understanding. Of course, they haven't 
put out the final rule yet; but they are working on it.
    Mr. Cooper. Are all of the panelists equally hopeful that 
GASB is about to do this positive step?
    Ms. Norcross. I know they are looking at it, so I am 
hopeful.
    Ms. Lav. They have taken all the comments. They had a draft 
rule in September, and they are very far down the line.
    I think it is appropriate because all of the stakeholders 
have had a chance to comment. It is not something that is being 
imposed by fiat. Various people object to various parts of the 
rule, but it is going to be a standard rule, and better than 
the one we have.
    Mr. Cooper. So does the Manhattan Institute and the 
University of Pennsylvania Law School concur in this?
    Mr. Skeel. I'm not following this that closely, so I will 
be agnostic on this.
    Ms. Gelinas. I will be as well. I have no prediction on how 
they will come out.
    Mr. Cooper. You mentioned earlier rating agency analyses. 
The rating agencies don't have the credibility that perhaps 
they once had prior to the housing crisis. Are the rating 
agencies on top of these developments between and among the 
States and municipalities?
    Ms. Lav. I think they are. There are rating agencies, and 
then there are a whole host of other financial analysts out 
there that specialize in looking which are not the rating 
agencies, which I agree have lost some credibility, who look at 
this and who have specialists who spend all of their time 
looking at State and local finance. I mean, I think they have a 
pretty good handle on what is going on.
    And to the one, which I cite in my report, they are saying 
there is no major chance of a contagious default. If there are 
a couple extra defaults, they are likely to be in small things, 
like sewer districts and not in major areas.
    Mr. Cooper. I see that my time has expired. Mr. Chairman, I 
thank you.
    Mr. McHenry. I thank the gentleman.
    If it is OK with the panel, we have an opportunity to go 
for a second round of questions if there are no pressing 
concerns this morning. So with that, I recognize myself for 5 
minutes.
    So the definition of default is to fail to fulfill a 
contract, agreement or duty. To fail to perform, paying or make 
good. So if we look at default in the bond market, does the 
bond market define that narrowly which is to make good on your 
payment to me, or can we as policymakers define it more 
broadly, which is failure to fulfill an obligation to the 
people you are serving, to pension holders, for instance, and 
not being able to pay pension holders? Or could it be not 
making good so you have to sell a city or State asset in order 
to pay bondholders, which is an interesting piece here. But 
beyond that, as Federal policymakers, are we making the matter 
worse through our transfer payments to the States? There has 
been some point of reference in testimony here today that is, 
in fact, the case. Ms. Norcross, your written testimony 
includes some discussion of this. But to the tune of hundreds 
of billions of dollars a year, there are Federal transfers to 
States. There are also Federal mandates on the States that are 
cost drivers to government. Can you touch on this and the 
implications it has obviously for the bond market and 
indebtedness of the taxpayers.
    Ms. Norcross. Well, of course the most well-known 
maintenance of effort would be currently with the Medicaid 
requirements on the States. And there are many other grants and 
aid that are handed out to the States that occasionally come 
with maintenance of effort requirements or may encourage that 
municipality or government to need to raise taxes to support 
the spending.
    I don't know if I answered your question.
    Mr. McHenry. You did.
    Now, there are certain States that are in difficult fiscal 
situations. I know some research has been done on this. So does 
that, the difficulty of policymakers to balance the budget, 
does that have a bearing on their credit rating? Certainly it 
does, one would believe.
    Ms. Gelinas, in terms of your discussion of various sub-
groupings of the State, not the general obligation bonds, but 
obviously the dormitory authority or a road authority, does 
that have a bearing, the State revenue sources, whether or not 
they are sustainable? Can you touch on that?
    Ms. Gelinas. Sure it does. Without saying whether or not 
the ratings agencies are right or wrong, either on the broad 
issues or narrow credits, the ratings agencies do have a good 
understanding that each bond is different even at the State 
level.
    So California, for instance, they have said very clearly 
paying debt service on general obligation bonds, this is one of 
two top priorities for the State. That even if California has 
massive budget deficit, they pay these bonds first before they 
pay anything else. So ratings agencies look at that, see the 
structure of the law and precedents, and that goes into the 
analysis.
    Other States it may not be as high a priority, but it is a 
very high priority in every State. And then when you look at 
things like bonds that are tax secured where the State has said 
we pledge this sales tax to pay bonds before we use the sales 
tax for anything else. That is actually higher than a general 
obligation bond. That gets AAA ratings in a lot of cases 
because of that.
    So you have to look at each of the payment streams, the 
character of the State, the willingness of the State to pay the 
debt. And sometimes, frankly, the willingness of the State to 
make bad decisions.
    We saw in Illinois, the State raised taxes to give comfort 
to the bondholders. So trying to get more market discipline in 
getting the bondholders to care more about the fundamentals, it 
doesn't necessarily get you the good, long-term decision for 
the State. If the response of the State is to raise taxes, it 
may make the long-term situation worse, not better.
    Mr. McHenry. I certainly appreciate that. And in today's 
Wall Street Journal, there is a story about this hearing, and 
they reference that California borrows billions of dollars each 
year to cover seasonal shortfalls in its cash-flows. Illinois 
is proposing to issue an $8.7 billion debt restructuring bond 
to pay past due bills, and a $3.7 billion bond to make required 
pension contributions to its pension system.
    There is a larger discussion here about whether these 
States will be able to afford higher interest rates on these 
bonds following the end of quantitative easing and the impacts 
that will have on their pension fund gap. So I can just ask the 
panel to make comments on that briefly, and we would certainly 
like to hear your testimony.
    Ms. Gelinas. Right. Higher interest rates are certainly a 
risk not having to do with the fundamentals of the municipal 
bond market, but also how do global investors feel about the 
prospects of inflation in the United States? If Treasury bond 
rates go up, it is likely that municipal bond rates will go up 
at the same time.
    Mr. Skeel. I will just add those effects are likely and 
already are disproportionately borne by the States that are in 
big trouble. So California's interest rate is much higher than 
other States' interest rates. That is what we would expect. And 
I think in the long run, that is what we want. That is what we 
want the bond markets to be doing.
    Ms. Norcross. I concur with what Professor Skeel said.
    Ms. Lav. I would distinguish those different things. 
California issues revenue, and a few other States issue 
anticipation notes. They pay them back within the same year. 
That is not borrowing for operating expenses, it is just 
changing the timing of their borrowing; whereas the Illinois 
bonds are actually borrowing for operating expenses, which is a 
big distinction.
    Of course, the expenses will go up if interest rates go up. 
And as I showed, that total interest on bonds are, depending on 
the source used to calculate, only 4 or 5 percent of total 
State and local expenditures. So again, this is not something 
that is going to break the bank if it goes up from 4 percent to 
5 percent to 6 percent of expenditures. It is on the margin. 
They will have to accommodate it, but it is not going to break 
the bank.
    Mr. McHenry. Thank you.
    Mr. Quigley is recognized for 5 minutes.
    Mr. Quigley. Again, thanks to our panelists and the 
chairman for participating in this. It is a very good first 
step by the chairman and the committee on an important issue.
    Before I ask you my last question, the thoughts for local 
governments, State and local governments, is, from my point of 
view, the mission matters. We often hear so much that people 
don't like government. But when it comes to local government, 
when they call 911, they want a fireman or an ambulance or a 
police officer to respond, and they want to know that when they 
cross a bridge, it is safe.
    So much of local government strikes so close to home. It is 
where the wheels hit the streets. So what we are talking about 
today is so important because poor financial management can put 
all of those things at risk. So beyond the financial management 
dealing with pensions and so forth, it is really the notion 
that governments need to look at themselves and reinvent 
themselves. And I am not just speaking as a Congressman, but I 
was a Cook County commissioner for 10 years. All local 
governments need to reinvent themselves, streamline and 
consolidate, not because they don't matter, but because they 
matter very, very much. So there is a lot at stake here.
    I want to commend the panelists. With one exemption, you 
kept your bond that you weren't going to mention the name, and 
shall not be mentioned. But it is still a big question. The 
public wants to know to what extent could there be significant 
defaults or significant bond defaults in the year 2011 or 2012?
    Ms. Lav. I don't think there will be a city or a county 
that defaults. I think there will be some defaults in special 
districts and on revenue bonds. So, for example, in Florida, 
there were bonds issued for sewers in a development that never 
got built because the housing bubble burst. Well, there is no 
way--you can't pay back those bonds because there is no sewer 
revenue coming in. There are those kinds of things around the 
country that are going to be a bit of a problem and there could 
be defaults or restructuring.
    As the chairman said, the term ``default'' is being used in 
a number of different ways. I use it as you don't make the 
interest payment on the bond, not that you find some other way 
to provide it. Again, there are always some projects that go 
back in a bad economy. But I don't think there will be any 
major, large city or county that defaults. And I think by and 
large, that even for smaller ones that the States will step in. 
And, you know, we have a control board now in Nassau County, 
New York. We will see quite a number of control boards, I 
think, where States come in and impose control boards on 
localities that are trouble and make them figure out a plan for 
working their finances out.
    Mr. Skeel. I also don't think there will be 50 to 100 
defaults. But I think it is really important to keep in mind we 
don't know. Probably 50 States will survive, but if only 48 
States survive the current crisis, we are in trouble. And I 
think we really need to plan for that. We need to plan for 
surprises in a way that 2008 we had not planned for surprises.
    Ms. Gelinas. As a democratic people in each State, we don't 
have to wait for the bond market to make commonsense decisions 
today. We know State by State and for the Nation as a whole, we 
have to control our health care costs for public employees, as 
well as other people as well; retiree pension liabilities. 
These are all things that if we do not get a handle on them, we 
will not be building or repairing roads, bridges, transit 
because we are paying these growing retiree costs. These are 
things we can fix today. We shouldn't and don't have to wait 
for bond markets to tell us what we should be doing already.
    Ms. Norcross. I would concur with what Ms. Gelinas said.
    Mr. Quigley. Thank you. I yield back the balance of my 
time.
    Mr. McHenry. Mr. Cooper is recognized for 5 minutes.
    Mr. Cooper. Thank you, Mr. Chairman. I would like to thank 
you again and the ranking member for this excellent hearing.
    Back to the question of individual investors. If I am an 
individual bondholder today or a local taxpayer who is thinking 
about maybe buying some of these bonds, what is the easiest way 
for me to find, on the Web or another source, the credit 
status, credit rating, financial soundness of the entity in 
which I am investing or am living?
    Ms. Lav. Bond prospectus have a whole lot of information 
about the finances of a State or locality. It depends.
    Mr. Cooper. A prospectus is a big, long, legal document, 
sometimes hundreds of pages. It is very different for the 
average person. What is the best way for a consumer who is 
maybe at the broker's office saying I want a tax-free bond, 
tell me what I should buy? How do you find out that 
information? How do you tell whether you are living in a 
creditworthy jurisdiction or not? This is the information age. 
Is there a Web site that you can go to and find out with 
relative ease, small town U.S.A., is it worthy or not?
    Mr. Skeel. I think it is fairly difficult. You have to 
piece together information. But all of the brokerages publish 
reports or put out reports on individual bonds. Certainly if 
you go to a broker, you can get that kind of information. But 
to assemble it together yourself, I think, it is difficult.
    Ms. Lav. That is why most people do rely on financial 
advisers and on brokers rather than make their own decisions. 
Or at least for information.
    As Ms. Gelinas said, it depends on what kind of a bond it 
is. You may be wanting to know about the possibility of are the 
tolls going to pay back the bond on this highway. Or it may be 
full credit, in which case you need to have some sense about 
the budget of the entity and its long-term prospects.
    Mr. Cooper. When Ms. Gelinas said earlier that individual 
citizens should take it upon themselves to get ahead of the 
bond markets and anticipate bad practices, it is very difficult 
to do that. You really have to be a student of this to 
understand what is going on.
    Ms. Lav. Right. And I think people, just like I go to a 
lawyer or I go to a doctor. I mean, I am a public finance 
person, but everybody isn't and they need to go to an adviser.
    Mr. Cooper. But for the individual investor, it should be 
made relatively easy. And it is my understanding that some of 
the brokerage houses may be affiliated with investment banks 
that help underwrite the bonds, and they have an interest in 
making those bonds look good.
    Ms. Lav. Yes, that may be the case. You know, there is not 
a lot of ways that an individual can investigate. Most towns 
have their budgets on the Web site. I can find them, but it may 
not tell you everything you want to know.
    Mr. Cooper. We can compare almost everything else in life 
through easily accessible Web sites. These important financial 
instruments, why can't we get an easy handle on these?
    Ms. Lav. There are 80,000 jurisdictions in the United 
States--some people say 90,000--that issue bonds. It is quite a 
large undertaking and one that maybe somebody would want to 
undertake. But it would be a big deal.
    Mr. Cooper. Perhaps a more relevant question is so many 
people buy a bond fund, which may have a few bad apples in it. 
How do you tell what is in your bond fund? It is my 
understanding that with the housing crisis, they bundled 
subprime credits and when a few more went under than expected, 
that tainted the whole package.
    Ms. Lav. That was a different kind. Those were kind of what 
people call sliced and diced securities where people couldn't 
know what the origin is.
    Mr. Cooper. That is not done with muni bonds?
    Ms. Lav. No. Never. It is not done ever.
    Ms. Gelinas. The bond funds, without endorsing or not 
endorsing them, there is at least something there, unlike with 
something like a collateralized debt obligation built on 
mortgage bonds built on more mortgage bonds. Some of these 
things were rated AAA. They ended up being worth literally 
nothing. I don't see how that would be the case here, even if 
we did see small scale municipal and project defaults. It is 
hard to conceive waking up and having a AAA rated municipal 
bond fund being worth nothing.
    However, I think your other point is very important, that 
individuals own these bonds, but they don't own them directly. 
They own them through money markets, $300 billion worth of 
State and local debt in money market funds, and there is an 
issue here of financial intermediation and the dealers 
responsibility, that these are the large investment banks. They 
run these funds, they hold many holdings on their own books. 
And if we haven't succeeded in getting financial discipline 
into these firms that still believe, in many cases, that they 
are too big to fail, they are not going to be worried about 
State and local debt because they think Congress will bail them 
out, not the States.
    Mr. Cooper. Would any of you invest today in a bond fund in 
the hunt for yield with higher tax-free interest rates of 
project funds in Nevada, southern California, Florida? Would 
you put your lifesavings or your pension fund in a fund like 
that, especially since it is apparently quite difficult to find 
out about the merits of each individual project?
    Mr. Skeel. I would be careful, but I certainly wouldn't 
steer away from the muni market.
    Mr. Cooper. I asked about project funds because those would 
be most likely to have problems.
    Mr. Skeel. You would have to look at the project.
    Mr. Cooper. But apparently, that is almost impossible to do 
unless you are a bond lawyer and are willing to read 200 pages 
per project.
    Mr. Skeel. Well, I mean, if you are going to invest in a 
particular project----
    Mr. Cooper. But this would be a bond fund with lots of 
these projects. It just seems to me that we are not giving 
consumers, individual investors, enough information here. At 
least that is easily accessible. But I see that my time has 
expired. I appreciate the chairman's patience.
    Mr. McHenry. I certainly appreciate the gentleman's line of 
questioning. If the panel wants to go through, the question 
was: Would you invest in State municipal bond funds; you, 
yourself? Yes or no; maybe, if you all want to answer, that 
would be great.
    Ms. Gelinas. I think there is a very real problem with 
trust, people's trust in the financial industry and in trusting 
their financial advisers and trusting the managers of these 
bond funds, and that issue is not going away any time soon.
    Mr. McHenry. Ms. Norcross.
    Ms. Norcross. I would probably ask my financial planner.
    Ms. Lav. I have never actually invested in municipal bonds. 
It is just not my style of investing.
    Mr. McHenry. I thank the gentleman from Tennessee for his 
line of questioning.
    With that, we will go to Mr. Walsh of Illinois.
    Mr. Walsh. Thank you, Mr. Chairman. And thank you for 
holding such an important hearing. Like the ranking member, I 
am from Illinois as well. Illinois is a mess. We all know that. 
No way is the Federal Government going to bail out my State. My 
voters, our constituents won't allow it. I feel like I left the 
movie right before the good part, and I am sure the case was 
being made that bankruptcy is not feasible. So no bailout. 
Bankruptcy isn't feasible.
    Let me start out with a quick round-robin question. Give me 
your 20-second solution just so I can walk out of here with 
that take away. We are not going to bail you out. Bankruptcy is 
probably not feasible, so what are the States going to do? Give 
a quick one to that.
    Ms. Gelinas. Well, I think voters in many States are 
already doing the right thing. We have new Governors from both 
parties that are starting to address what do we do about 
pensions for future employees? What do we do about Medicaid 
costs? Something Congress can certainly help with. These are 
questions for voters in the individual States pressuring their 
own lawmakers to change State laws and, in some cases, State 
constitutions, not something that the Federal Government can or 
should do for them. So in some ways the system is working, if 
imperfectly.
    Mr. Walsh. I guess my question is if there is going to be 
no bailout from us and a bankruptcy is not feasible, a State is 
falling off the cliff, let's imagine that one in the next 3 or 
4 months literally is going to fall off the cliff. We can 
change laws that will impact things in the future, but what do 
you do for that State that has just fallen off the cliff?
    Mr. Skeel. My answer is going to be I really think we need 
to put a bankruptcy regime in place to deal with precisely that 
problem. That is the only problem we absolutely need bankruptcy 
for. I would add one thing to that: I agree that States are 
doing the right thing. I hope the optimism that we have heard 
today is correct, that most of them can muddle their way 
through. But some measures are a lot tougher than others. For 
instance, pension reform in a State, while there is a lot of 
debate in Illinois about what can and can't be done right now, 
but in many States it does require a constitutional change. I 
think that is pretty unrealistic. So some of the options are 
more feasible than others.
    Mr. Walsh. Ms. Norcross, your State is falling off a cliff; 
what are you going to do?
    Ms. Norcross. I would say close the defined benefit plan 
and figure out how you are going to pay out what has been 
accumulated.
    Mr. Walsh. Ms. Lav.
    Ms. Lav. I think States can use their normal processes of 
dealing with their taxes and their expenditures to set 
themselves on a right path. Illinois has a particularly deep 
hole. I have been writing and talking about Illinois' problems 
for the last 25 years of its fiscal mismanagement. I am a 
native Chicagoan. But it just needs to do those things it needs 
to do to get out of it and to bring itself back to balance. It 
has the tools. It just needs to use them.
    Mr. Walsh. Thank you. In my remaining time, let me quickly 
ask one quick question about market risk. Bill Gross who 
manages PIMCO, one of the largest mutual funds in the country, 
he stated that a low or negative real interest rate for an 
extended period of time is the most devilish of all policy 
tools. It is interpreted to mean, what he is saying is that the 
Fed's action to lower interest rates helps our debtors, such as 
States and municipalities, while harming all those who worked 
hard and saved money.
    Ms. Norcross, Ms. Gelinas, quickly, in effect, the Fed is 
enabling debtors to reduce their debt on the backs of those 
that saved money; is that right?
    Ms. Norcross. I would hesitate to say that right now.
    Mr. Walsh. Ms. Gelinas.
    Ms. Gelinas. There is complacency. States and cities have 
borrowed at very low rates not just for the past couple of 
years in extreme conditions, but really for two decades now. If 
rates go up, including possibly way up, they will have to get 
used to a very different environment very quickly.
    Mr. Walsh. Could you argue that the Fed's quantitative 
easing program is in effect, has in effect been a bailout for 
States and municipalities?
    Ms. Gelinas. Sure this is a bailout for anyone who owes 
money. States and municipalities may not be the biggest 
proportionate benefitter from this, but it certainly helps 
them.
    Mr. Walsh. Ms. Norcross, you concur?
    Ms. Norcross. I concur.
    Mr. Walsh. Thank you.
    Mr. Chairman, I yield back. Thank you.
    Mr. McHenry. Ms. Buerkle from New York is recognized for 5 
minutes.
    Ms. Buerkle. Thank you, Mr. Chairman, for hosting this very 
important meeting. Coming from New York State, as you can 
imagine, this is a concern on many of our minds. I apologize, 
we've had a number of hearings today for being in and out. I 
appreciate your time this morning.
    The first question I want to ask is regarding actually the 
stimulus money and the fact that so much of it was paid to the 
States. Do you think that was a way the States were sort of--it 
put the States off, they didn't have to really face these 
issues head on, and so it actually delayed and now the States 
have to reckon with the situation? That is a question for any 
one of you.
    Ms. Lav. I am happy to respond to that. When that money 
first came out in 2009, we would have seen it covered about a 
third of the State's deficits. In that year, we would have seen 
very sharp cuts in education and health care. We would have 
seen millions of people losing their health insurance, and the 
States were poised to cut people. We would have seen many, many 
more layoffs of teachers and other public employees, which 
would, in fact, have potentially delayed recovery because you 
take that demand out of the economy, and the stimulus actually 
provided a boost to the economy that was very important.
    So now, as the stimulus is ending, at least State revenues 
are beginning to grow again. They are still below 2008 levels, 
but they are beginning to grow again. So States have a little 
more ability to absorb the end of the stimulus. They are 
proposing very major cuts in budgets this year. But it is 
probably better that they are doing it now as the economy is at 
least on something of a growth path than if they did it in the 
depths of the recession which could have been very damaging to 
the economy.
    Ms. Buerkle. But it seems to me those decisions they are 
making now, they should have made a year ago and actually got 
their fiscal houses in order. It appears the stimulus just 
delayed reckoning with the reality of the situation. Mr. Skeel.
    Mr. Skeel. I agree. There is some case for some of the 
stimulus money going to the States, but there is no question in 
my mind that it has delayed the restructuring.
    Ms. Gelinas. Yes, I would agree with that. There was a 
missed opportunity in that Congress might have considered 
saying to the States: we will give you a dollar today in 2009 
if you take steps to cut your future liabilities by a dollar 10 
years from now. So fix the pensions, fix the health care and 
Medicaid costs, give them operating aid now, but use it as 
leverage to work on the long-term problems. That was something 
that was not done.
    Ms. Norcross. I would add to that some of the stimulus 
expanded some spending and is leading to cuts that need to be 
taken today. States, Virginia, New Jersey, deferred their 
pension payments. They were not making the tough choices.
    Ms. Buerkle. Thank you. While I still have some time, if I 
could ask another question.
    Mr. Skeel, regarding the possibility of bankruptcies in 
some of the States that are so financially strapped, if, in 
fact, they did declare bankruptcy, would that affect the 
borrowing abilities of healthier States? Does that impact a 
State that kept its fiscal house in order, and now they are 
going to be impacted by some of the States that did not?
    Mr. Skeel. I think the impact would be very limited. As I 
was saying a few minutes ago, the bond markets have the ability 
to distinguish between States that are in good fiscal shape and 
States that are not. It is really not like the big banks in 
2008 which were really connected to each other, had the same 
kinds of assets, the same kinds of problems. The States really 
are independent. So I think a State that is in good fiscal 
health would continue to be able to borrow just fine.
    Ms. Buerkle. Thank you.
    Ms. Gelinas, I think in your opening statement you 
addressed that. Would you like to address that issue as well?
    Ms. Gelinas. Sure. I would respectfully disagree. Markets 
can distinguish among States, but they cannot do it 
instantaneously or even in a few weeks or even months. So 
changing the law in this way, really sweeping away half a 
century's worth of precedents, it would take a long time for 
markets to adjust to that and healthier States would suffer 
during that timeframe as well.
    Mr. Skeel. If I may add one last remark on that, when you 
look at countries that have run into trouble, Argentina, for 
instance, which is about as profligate as you can get, it is 
remarkable how quickly they can go back to the markets. I 
really believe markets respond a lot more quickly than people 
tend to think.
    Ms. Buerkle. Thank you. I yield back.
    Mr. McHenry. Thank you so much for your line of 
questioning. I have just three more questions that I wanted to 
pose to the panel, if that is all right with you all.
    If you look at the public sector employee unions versus 
private sector employee unions, the public sector unions now 
account for more than private sector unions. It is an 
interesting crossover we have had just in the last 2 years. On 
average, public sector workers make $14 more per hour in total 
compensation, wages and benefits, than their private sector 
counterparts.
    Ms. Gelinas, you have written about this, I know, but if 
you can testify and say here today, it seems to me that public 
sector employees and private sector employees are living in two 
separate economies. What are the ramifications of that, and 
what is really the root cause of that disparity?
    Ms. Gelinas. Yes, and I should be clear that it differs 
from State to State. Some States, particularly the northeastern 
States, Illinois, California, offer much greater power to 
employees to collectively bargain. Their benefits are 
commensurately much higher. Generalizing the problem, it would 
not be so much the wages as it is the benefits because these 
are open-ended liabilities that States and localities are 
taking on. Right now they are uncontrolled.
    So one aspect of getting these under control is to start to 
switch new civilian employees, a good first start, into 401(k)-
style pension plans, just as the private sector has. So you are 
getting rid of an open-ended liability for the State in the 
future.
    The same thing with health care benefits. In many 
municipalities, certainly not all of them, workers do not pay a 
share or anywhere near the share of their own health care 
benefits that private sector workers pay. Asking workers to pay 
more for their own health care do much to help States and 
cities with these liabilities.
    Mr. McHenry. So you mention switching from a defined 
benefit plan to a 401(k) style which most Federal employees 
have, for instance, just as a for instance. That is one policy 
change that we could--that the States could enact. What are the 
prescriptions that the Federal Government can take action over 
to help stem the tide that we see coming? Ms. Lav talked about 
the loss of revenue, and the fact that stimulus funds sort of 
relieved the States of that burden of having to lay off 
workers. But if you look at local school boards right now, with 
the loss of stimulus funds, you are having hundreds of people 
show up at school board meetings because they are talking about 
layoffs.
    What I believe I saw and I believe a lot of folks saw was 
that the day is coming, the day of reckoning is coming when 
those stimulus funds run out. And rather than realizing it 2 
years ago and making changes, they are having to do it now. 
What are the things that we here in Congress, what policy 
changes can we make to help stem this crisis? I will pose that 
for everyone. We will start with Ms. Gelinas.
    Ms. Gelinas. One area where it may be most straightforward 
for Congress to help States is in Medicaid because this is not 
an issue where Congress would be telling States you have to 
change your pension plan; you have to change the way you govern 
yourself. Medicaid is currently a program that encourages 
States to spend more, because when a State spends a dollar 
more, sometimes it gets more than a dollar back from 
Washington. Gradually changing Medicaid into a block grant 
program where you offer a set amount of money, increases on the 
set formula, and the States are encouraged to innovate and cut 
costs within that, reward them for cutting costs rather than 
raising costs. This would approach another big chunk of their 
costs, current and future.
    Mr. McHenry. Mr. Skeel.
    Mr. Skeel. I agree that Medicaid is the most obvious place 
to do things. There are real limits on what you all can do say 
with pensions and things of that sort simply for State 
sovereignty reasons. So places where there is already Federal 
funding are the places where I think you look first.
    Mr. McHenry. Ms. Norcross.
    Ms. Norcross. I concur that Medicaid and other areas, K 
through 12 education and where there are mandates that increase 
fiscal pressure on States.
    Ms. Lav. I don't think on the areas we are talking about 
today that there is any need, as I said, for Federal 
intervention.
    Mr. McHenry. Other than money?
    Ms. Lav. Well, I am not asking for the extension of the 
stimulus. I mean, it was unfortunate that it was designed so 
that the economy be recovered when the stimulus ended. Revenues 
are still below their 2008 levels, so of course, at the end of 
the stimulus, States were not able to get back to where they 
were. So helping the economy, there is not much you can do to 
help the economy right now either, necessarily.
    But with respect to Medicaid, I think you can easily talk 
about a block grant, but Medicaid is actually more efficient in 
many ways than private insurance per individual matched for 
health conditions. So I think that the best thing would be to 
figure out how to control the rate of growth of health care 
costs in the economy wide.
    Those scary GAO numbers that Ms. Norcross mentioned are 
entirely driven by the rate of growth of health care costs. If 
health care costs continue to grow faster than GDP, States are 
going to have trouble coping with that. So will the Federal 
Government. It is a major driver of the Federal deficit, and 
figuring out how to bring them under control is the best thing 
to do.
    Mr. McHenry. The final question of the day, and this is 
something that I intend to ask future panels as well. We are 
going to have a series of hearings about this fiscal crisis at 
the State level and the ramifications of not addressing it, and 
this is the opening of it. We wanted to hear from informed 
individuals to start this process. But I would like for you 
all, if you could, I'm asking you on the spot, but in the 
future as well, tell us who we should hear from next: bond 
market participants, credit rating agencies, pension holders, 
unions? If you could, tell me one, two, three people or 
entities we should hear from. Ms. Lav? We will go right down 
the line.
    Ms. Lav. Yes, that was a pretty good list. Financial 
analysts. There are several who have a very good handle on 
this. I can suggest a few and send them to you. And of course, 
unions have a major stake in this. You should hear from them. I 
mean, I think you also should listen to the Governors and the 
mayors.
    Mr. McHenry. Ms. Norcross.
    Ms. Norcross. I concur, that is a good list to start with. 
And also consider calling those who are involved in education 
finance and financing other policy areas.
    Mr. Skeel. I would just add, I think you all should talk to 
pension lawyers because these issues are both economic and 
legal. I think you need to see the whole picture.
    Ms. Gelinas. All of those people, and I would also suggest 
speaking with infrastructure people, because the other side of 
this is that States have to grow. The private sector can't 
create jobs when we have infrastructure that is decaying, and 
so how can States spend Congress' money and their own money, 
get the biggest bang for their buck in infrastructure and help 
grow States so these liabilities can be better controlled from 
that end as well.
    Mr. McHenry. Thank you. And I certainly appreciate your 
testimony, and I appreciate the opportunity to hear from you. 
Thank you for your time. Thank you for spending the morning 
with us. Thank you so much. And this meeting is adjourned.
    [Whereupon, at 11:25 a.m., the subcommittee was adjourned.]
    [The prepared statement of Hon. Elijah E. Cummings 
follows:]




                                 
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