States Have Much Worse Debt Ratios Than Greece

March 31, 2010 at 3:58 am (Banking Crisis)

What’s the difference between 21% debt to GDP and 59% debt to GDP? One is the reported figure for the State of New Mexico, using creative (Enron-style) accounting and one is accounting using the mark-to-market method. If you aren’t familiar with mark-to-market versus “mark-to-value” it’s sort of like a speed limit. Normally, if you are going 80 MPH, and a cop pulls you over in a 55 MPH zone, he or she will say you were going 25 MPH over the speed limit. That’s mark-to-market. Reality.

Imagine if when you were going 80 MPH, you were able to average out the speed of the people around you and compare that to your speed to determine if you were going too fast. Therefore, if you were in a 55 MPH zone, and everyone around you was going an average of 77 MPH, you were only going 3 MPH faster than everyone else and if a cop pulled you over, he didn’t say you were going 25 MPH over the speed limit. He said you were going only 3 MPH over the speed limit, which, in retrospect, not only would probably get thrown out by a judge but probably wouldn’t get you pulled over in the first place. That’s mark-to-value. Essentially, if everyone else is breaking the law, you’re only breaking the law to the degree you break it more than them. At first glance this seems somewhat logical. The problem happens when, for example, everyone decides driving 90 MPH in a school zone is appropriate. If you are going 85 MPH in a school zone, not only are you now not speeding, but you’re actually playing it safe.

Currently, if banks marked their assets to market, they’d all be bankrupt, even with the bailout money, so as of last year, they are all allowed to use mark-to-value accounting, which says essentially that banks get to determine themselves what their assets are worth. So, if they have a lot of repossessed houses that would only sell today for half of what they paid for them, they are still worth what they paid for them — not half, because they’ll be worth that someday, and anyway all the other banks say their foreclosed houses are worth the higher amount too. Forget that the value of something is determined by what you could sell it for today, not in a distant future.

It would be like if a person could say their stocks, even though selling at $10 today, are really worth $20, because they’ll be worth that someday. Or their stamp collection, while worth $3 now, is really worth $100, because they need only one more stamp to make the collection complete. In other words, not reality. It’s not reality because, naturally, one cannot guarantee the item will be worth more in the future, regardless of any calculated probability.

Anyway, this fictitious accounting is what the individual States are currently using to determine how much debt (compared to income) they are holding and how well their pensions are funded. Not surprisingly, there is a wide gap between the two methods of accounting. How wide? Well:

These states are much worse off than the “states” in the EU, such as Greece. Remember that the next time “recovery” is chanted on all the happy media heads.

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