This Halloween, we are resurrecting our “Zombie Index” to identify some scary state governments.
Who are the biggest zombies?
- New Jersey
These state governments are in relatively bad financial condition and may also pose higher risks to their citizens and taxpayers from “gamble for resurrection” investment policies, on top of the financial burden they have already accumulated.
The index is inspired by the work of Edward Kane, a professor of finance at Boston College. Kane wrote books warning about the developing crisis in the bank deposit insurance system in the late 1980s, before and during the savings and loan crisis.
Kane coined the term "zombie bank" to refer to banks and thrifts that were effectively insolvent but allowed to remain open, in part with deceptive accounting.
Kane called these banks "zombies" as they were really dead but allowed to walk among the living. False accounting delayed loss recognition and regulatory intervention. The possible socialization of losses through the government safety net for banking firms gave zombies incentives to take large risks -- particularly if insiders gathered any upside but taxpayers would take the downside.
Zombies had incentives, in Kane's words, to "gamble for resurrection." These incentives amplified the cost of resolving the savings and loan crisis to taxpayers.
Today, similar incentives could be at work in state and local governments, particularly those with sorely underfunded pension plans. Citizens and taxpayers may be threatened by risky investments in those plans, similar to how they paid a price for risky assets in thrifts.
For further background on Kane’s analysis, see his 1989 article “The High Cost of Incompletely Funding the FSLIC Shortage of Explicit Capital.” For a timely and relevant recent article, see “The Risks of Public Pension Systems Reaching for Higher Investment Returns” by Jen Sidorova. You can view how we constructed the Zombie Index at the glossary entry at our Data-Z website.