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The scariest Zombie States in the nation

October 30, 2015

We have developed a Zombie Index for the 50 states.  This index was inspired by the work of Ed Kane, a finance professor at Boston College and past president of the American Finance Association.  Kane wrote two books warning about the savings and loan crisis a few decades ago, before we really knew what hit us. 

During that work, Kane coined the term ‘zombie bank.’  A bank is a zombie if is effectively insolvent but allowed to remain open. That was the case for numerous institutions in the savings and loan crisis, as regulators did the bidding of their regulated and enabled them to stay in business with untruthful regulatory accounting overstating their solvency.  Part of the problem was something called ‘forbearance,’ where regulators delayed closing or otherwise resolving failed institutions with untimely accounting.

It was in that period that the already-high taxpayer costs to resolve the situation ended up mushrooming.  S&Ls allowed to stay open had an incentive to ‘gamble for resurrection,’ in Kane’s terms, as insiders stood to reap any gains, but impose any losses on the general public.  Many of those gambles failed, effectively socializing risk and trebling the cost to the taxpayer of resolving the crisis.

Today, we have an alarmingly similar situation in state and local government pension funds.  Many state and local governments are facing bills far higher than assets available, even as government accounting principles have allowed them to keep the largest share of those bills (retirement benefit obligations) off the government balance sheet.  Leaders of severely underfunded plans may have an incentive, like the insolvent S&L managers, to take higher risks to get out from behind their 8-ball.

That was why we decided to come up with a Zombie Index, given our proprietary analysis and the wide variety of economic, demographic, and financial data on Truth in Accounting’s “State Data Lab” website.

The Zombie Index is based on three main factors – Truth in Accounting’s “Taxpayer Burden” metric, the timeliness of government financial reporting, and the share of total bills not fully disclosed on the government balance sheet.  These three metrics help capture some of the main driving forces in the S&L crisis.  In turn, the Zombie Index can help identify states that may be more likely than not to be taking higher risk in their retirement plan investment portfolios – risks that may, or may not, pan out.

So, who are the biggest zombies, based on the latest data?  Ranked from 1 to 10, those states are:

  1. New Jersey
  1. Connecticut
  1. Illinois
  1. New Mexico
  1. Kentucky
  1. Hawaii
  1. California
  1. Massachusetts
  1. West Virginia
  1. Alabama

Taxpayers and citizens could be especially well served by efforts to monitor the risk and performance of investments supporting retirement benefit plans in these states.

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