News - Bill's Blog

Look out for Zombie States – not only on Halloween

October 25, 2021

We have updated our annual “Zombie Index” for state governments, based on our recently-completed survey of their latest audited financial reports. The Zombie Index identifies states that may have incentives to accumulate riskier investment portfolios in pension and other employee retirement benefit plans. Taxpayers and citizens have reason to be spooked, especially given financial market history lessons from the likes of the savings and loan (S&L) crisis in the 1980s.

We call it the “Zombie Index” based on the work of Edward Kane, a prolific and respected finance professor at Boston College. Back in 1985 and 1989, Ed wrote two books warning about taxpayer exposure to losses from bank deposit insurance schemes, before we knew what hit us in the savings and loan crisis. Ed coined the term “zombie bank” to identify effectively-insolvent banks that were allowed to remain open by regulators and others. Deceptive accounting principles greased the wheels for regulatory forbearance, making “zombies” appear to be solvent. 

Zombies had incentives, in Ed’s terms, to “gamble for resurrection.” Insiders could capture the upside of riskier investments, while prospective losses could be socialized through the government’s sponsorship (and ultimately, bailout) of deposit insurance systems. These incentives ended up magnifying taxpayer losses during the 1980s deposit insurance crisis. Those losses ran in the hundreds of billions of dollars and helped set the stage for the massive financial crisis of 2008-2009.

Let’s hope we aren’t repeating history with state and local government pension plans today. 

Our “Zombie Index” is based on six equal-weighted factors:

Truth in Accounting’s “Taxpayer Burden,” which is a per-taxpayer measure of overall state government financial condition. States with a Taxpayer Burden have negative net financial positions, on our accounting, and the larger the Taxpayer Burden the greater the depth of “insolvency.”

The change in TIA’s “Taxpayer Burden” since 2009, to capture the degree of financial deterioration (or improvement) since then.

The timeliness of states in issuing their annual audited financial statements. The greater the delay, the higher the “Zombieness.” (Note: California has yet to release its fiscal year (June) 2020 financial report and deserves special attention on this score.)

The difference between balance sheet-reported and actual retirement benefit liabilities in 2014, the year before the Governmental Accounting Standards Board finally began requiring those benefit obligations to appear as debts on the Statement of Financial Position. The accounting has been “fixed” since then, but the 2014 difference can still help capture Zombieness.

The degree to which state governments are still underreporting retirement benefit obligations on their balance sheet, for example, by using (as allowed) one-year-lagged results for their pension plans.

The extent to which governments are reporting potentially-misleading and confusing “Deferred Outflow and Inflow” accounts, which can be managed to artificially bolster reported net positions in the short-run.

We rank the states on each of these factors, compute an average of the rankings on the six factors, and then rank the states on that average. When states are still tied, we break the tie using factor number two above, the change in TIA’s Taxpayer Burden since 2009. 

In our latest analysis, the ten scariest Zombies were (in order from frightening to terrifying) Hawaii, Pennsylvania, California, Vermont, New Mexico, Delaware, Connecticut, Massachusetts, Illinois, and (the biggest Zombie) New Jersey. Citizens and taxpayers in those states should be concerned about the riskiness of the investment portfolios for pension and other retirement benefit plans. 

But citizens and taxpayers in all 50 states should be concerned -- not just for their own states, but for Zombie states as well. That’s partly why we developed the index. The potential socialization of losses through federal schemes impacts all Americans, exposing citizens and taxpayers in well-managed states to the troubles facing Zombies. 

You can review our state “Zombie Index” rankings at our Data-Z website. For example, here is a chart comparing the rankings for Illinois, Massachusetts and New Jersey to Utah, South Dakota and Idaho. Or click below to watch a short video on the rankings.

Let’s hope we aren’t facing another huge mess like the S&L crisis in public pension plans today. But this will be a vain hope without greater public concern, oversight, and discipline (including disciplinary action, where appropriate) for pension system managers, accounting standard-setters, and legislators.

 

 
 
comments powered by Disqus