Meredith Whitney's outlook gets even bleakerOctober 5, 2011: 2:26 PM ET
Meredith Whitney, CEO of the Meredith Whitney Advisory Group, was interviewed by Fortune's Nina Easton at the Most Powerful Women Summit.
Below is an unedited transcript:
NINA EASTON: Our next speaker is a familiar face with this crowd, Meredith Whitney, CEO of Meredith Whitney Advisory Group. I think a lot of you know Meredith's claim to fame. By the way, check out the Wall Street Journal's magazine this month, it's got some fab photos of you, and a great story.
Meredith sort of shot to fame by calling the banking crisis early. She put out a report on Citigroup on a Wednesday, and I think it was on Monday CEO Chuck Prince was out of a job. Now, however, she's raising alarms about something else, and that's state finances. We've all focused a lot on the crisis at our national level, the fiscal crisis at the national level. Meredith has put a lot of work in looking at what's going on at the state levels.
Let me just start by asking you, what do you see?
MEREDITH WHITNEY: I see most importantly, and to step back for a second, there's been so much focus on debt at the federal level. But there's no such sense of urgency at debt at the federal level. There's a sense of urgency at the state of the debt at the state level. And that's because 49 states have to balance their budgets every year. And why it's such an issue today is because federal stimulus in the form of the American Recovery Stimulus ran out in June. And what the federal government has done over the last several years is made the states so dependent upon federal transfers, so when federal transfers are taken away, the states have to cut dramatically. And your relationship with your government really starts at your state level, but more importantly at your municipal level.
And so, debt at all these variations, at the municipal level, at the state level, impacts everything, impact housing, the price of your home. And so, if you think about states cutting off aid, so the numbers work like this, most recent data is that federal transfers to states account for 35 percent of state revenues. States then transfer 40 percent of municipal revenues down the food chain. What states are doing across the board is cutting off that aid. So, when states are imbalanced, and for the last four years they've run over $400 billion in imbalances, the easiest thing they can do is cut off aid to municipalities. What they have done has been actually dip into their pension funds, meaning build up unfunded pension liabilities, and other post-employment benefit liabilities.
And what that means then is, as an example, if your neighbor takes on too much debt, it's your neighbor's problem. But if your state takes on too much debt, or your municipality takes on too much debt, it's your problem. So, people look at debt, general obligation debt on the state level and say, well, it's manageable, it's not that bad. But, in fact, pension liabilities have equal claim to tax dollars as state debt does. And other post-employment benefits, these are state employee insurance benefits, medical claims, they have equal claim to the tax dollars. So, if you look at that in aggregate, it's four times that of the debt, just general obligation debt.
So, what this means then is, the service, the debt service at these levels then starts crowding out monies that states would use to reinvest back in their states. And so, you have examples like in Nevada that 50 percent of their budget goes to fixed cost expenses. This isn't debt; this is debt including minimum payments to unfunded pensions, and other post-employment benefits. So, you have an issue in the country whereby certain states are going to look so much less attractive to businesses and to individuals, and certain states are going to look so much more attractive to individuals and businesses. That has an absolute effect on home prices. That has an absolute effect on demographics. That has an absolute effect on corporate behavior, and you're starting to see that.
So, there are examples and evidence of this across the board.
NINA EASTON: What are we going to see? Are we going to see defaults? Are we going to see spending cut to the barebones? Are we going to see tax increases? What's coming down the pike in the next year?
MEREDITH WHITNEY: So, there have only been three years in the past decade where states haven't had to remedy imbalanced budgets. So, what has happened has been in order to ‑‑ and today states, this is on a U.S. basis, spend 2-1/2 times that of their revenues, two-and-a-half times. And for all of you in the audience that is not sustainable. Since 2006, tax revenues, and this is on a national basis, tax revenues, state tax revenues are tracking 2006 levels, but expenses are $270 billion beyond 2006 levels. And there's no relation between your revenues and your expenditures, so there are built-in escalators on expenditures. So, this is a runaway train ‑‑ a lot of this has to do with pensions and entitlement programs ‑‑ a runaway train that is simply not sustainable.
And think about this again. When your neighbor takes on too much debt, it's your neighbor's problem. When your state takes on too much debt, it is your problem, because it's going to affect the price of your home, it's going to affect your taxes, which is going to be the biggest outlay of your total wallet, and it's going to affect your social services.
So, a big issue is, yes, you start to raise taxes. That was the first move. That was also helped by this over $484 billion in the form of this ARA spending. That delayed the pain. So, states balance their budget, 37 percent of their budgets over the past three years were balanced by federal transferring, so the stimulus money that has now worn off.
So, you're cutting deeper into the bone and this affects education, this affects the basic social services that we pay as tax dollars. And the fact that there's not more outrage around this is extraordinary. I mean if I told someone, I'm equally as guilty of this. I always vote for presidential elections, and I vote or ‑‑ I'm in New York, so I care about who the mayor is. But, basically at the local level, I don't even know who a lot of these people are. And I always blow it off, and this is really important. This is really important.
NINA EASTON: And it's interesting both at the fiscal level, I mean at the federal level, and now at the state level you're having a debate about cutting spending versus raising taxes. We had the Buffet proposal to raise taxes on the super-rich. How do you ‑‑ what's your thinking about that on the state level?
MEREDITH WHITNEY: Well, very specifically on the state level I'll give you a number of examples. New Jersey, so I love New Jersey, I was born there, has had such mismanaged finances that not only has it dipped into its pension liabilities so dramatically, but they've raised taxes beyond an acceptable level.
So, if you look at comparable tax rates you're going to do state arbitrage. So, I will live in Pennsylvania versus New Jersey, because there are favorable tax rates there. And so you've had an emigration of rich people, and Governor Christie has talked about this, as so many people have, an emigration of rich people who really comprise your best, and biggest, and deepest tax base. And so you're left with a lower tax base, and the folks who can't move, who don't have the benefit of moving, don't have the benefit of mobility end up then drawing so much more on your social services.
So, the mismatch becomes even larger, and you can see then states that have had ‑‑ Florida has been a big beneficiary of no income tax, and you've seen migration there. I think California is in a big pickle, because their finances are so mismanaged from a tax standpoint, and more importantly from a legislative standpoint, they make it so difficult for businesses to operate.
So, importantly, you're seeing not just individuals who want to optimize better tax rates, but corporations moving and corporations. And now you're seeing this gimmick whereby in the State of Illinois they did something that they needed to do, which was raise corporate and individual tax rates by two-thirds, but then the governor is now doing side deals trying to get companies to stay. So, that's classic New Jersey, right. That's the last thing you want to do, because then the well off are even more advantaged through loopholes and side deals.
NINA EASTON: let me ask you one last question quickly to this dismal scenario, broadly speaking, are we Europe? Is the same thing going to happen here?
MEREDITH WHITNEY: I think what will happen here is you will see social unrest, and I think that what is so disturbing to me going into this is this social divide, the us against them on every single level, Republicans, Democrats, who really cares, right, rich versus poor. You've got to raise a collective spirit in this country where we all are acting together, or you're going to have a social divide. So, when I get upset about something I'm going to get most upset about something when my kids are at risk, or my social services are cut, because that affects everybody. That's a universal benefit that we pay or we don't pay into, depending on where your tax bracket is, or if your tax bracket exists.
And that's what, if you look at Arab spring, if you look at any of the social uprisings within Europe, their basic social services are being compromised and two years ago in California, or a year-and-a-half in California they had, I wouldn't call it uprisings, but you had protests in Berkeley, because of the cost of state tuition. And you're starting to see this. Obviously, Wisconsin was a big example in terms of taking over the state capital. New Jersey, thousands of teachers protested in Trenton against Christie's proposal. So, are we Europe? We already are Europe; it's just a question of how you have to think about things on the issue of social issues, we already are Europe. In terms of a default scenario, does Europe ‑‑ that's hard to imagine and certainly the big difference in ‑‑ so, you can't compare them on a financial, on a balance sheet basis. And the best thing about this country is, we are so asset rich, so enormously asset rich. States have so much stuff that they can monetize and infrastructure then will play such a key role.
So, if you look at what Europe has invested in infrastructure versus what the U.S. has invested in infrastructure, and if you look at what Europe did in the '90s to de-lever, and European countries to qualify for the Euro, they sold assets, they privatized a lot of asset, so telecom, transportation, ports, airports, et cetera.
The states have to do that and can do that. And when you do that you raise a lot of money and can plug a lot of holes. And so we have so much more optionality as a country, we just have got to demonstrate political will, and hopefully avoid social division.
NINA EASTON: Well, on that uplifting note ‑‑
MEREDITH WHITNEY: It is. I wore my red, white, and blue, there's a lot to be ‑‑ like there's so much more going on that's great in this country.
NINA EASTON: Thank you so much, Meredith.
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