Are Some States Taking Higher Risks?

Edward Kane coined the term ‘zombie’ in a financial context back in the savings and loan crisis of the late 1980s.  ‘Zombie’ banks were effectively insolvent but allowed to continue operating.  Kane identified the accounting and regulatory practices that helped these ‘walking dead’ institutions cover up losses, and criticized how these practices allowed the zombies to ‘gamble for resurrection.’  Banks made riskier bets to make up their losses, given that taxpayers were on the hook for the downside through deposit insurance and other elements of the government safety net.  Many of those bets soured, trebling the cost of the S&L crisis.

Today, many state governments find themselves cornered by long-unrecognized, massive off-balance sheet obligations.  In turn, some of them may be taking higher risks in their investments or derivatives activities.  Such risk-taking may also end up increasing eventual costs to taxpayers to resolve the situation, much like the endgame of the S&L crisis.

The table above reports the ten states scoring the highest on our “State Zombie Index.” This index helps identify states that may be more likely than others to be taking on higher risk to address their debt problems.  The index relies on a weighted average of three components – the TIA “Taxpayer Burden” measure (50%), the timeliness of the annual report (25%), and the share of total liabilities estimated by TIA to be ‘not fully disclosed’ (25%).

In turn, we note one other source of risk-taking incentive.  Our “State Data Lab” includes a measure of interstate migration, through the annual United Van Lines migration survey.  This survey, constructed by one of the largest interstate shipping companies in the nation, produces a statistic for “% of outbound shipments” for the lower 48 states.  Looking at how the latest results for this survey (2012) line up with our Zombie Index, there is a tendency for states scoring higher on the Zombie Index to have higher outbound shipments in 2012.  This can be an added source of pressure / risk-taking incentive for states in difficult financial condition, given the implications for tax revenue.