As financial troubles intensified at S&Ls, their managers had an incentive to make bigger bets on risky investments. This was possible because private funding continued to flow into troubled banks. After all, government safety nets, such as deposit insurance, had the S&L managers' backs and it was other people's money that was on the line.
Edward Kane, a professor of finance at Boston College, called these troubled financial institutions "zombie banks." They were in essence financially dead but were allowed to continue operating. Managers were, in Kane's terms, "gambling for resurrection." These incentives amplified losses in the savings and loan crisis, which, depending on how you count, cost the taxpayers over $200 billion in today's dollars.
Kane's careful history indicates that this risky behavior and the financial conditions of these zombie banks were hidden by less-than-truthful accounting practices. There are alarming parallels to the financial crises faced by many state and local governments today.
These questionable accounting practices have allowed hundreds of billions of dollars of pension debt to accumulate outside governments' audited balance sheets. This state of affairs is all the more ironic in light of the balanced-budget requirements that are widespread in state and local governments. Government leaders regularly proclaim their fidelity in living up to the spirit of these laws. But false accounting practices have allowed real expenses (and debt) to accumulate anyway. Taxpayers and citizens have been left in the dark. At Truth in Accounting, where I am director of research, our leaders have documented the total taxpayer burden for all 50 states in each of the last several years.
The can has been kicked down the road for decades. Now a significant number of state and local governments find themselves near the end of the road. In 2015, the Governmental Accounting Standards Board will finally implement standards calling for more truthful representation of government pension obligations.
But haven't the cows already left the barn? Aren't government asset managers now gambling with other people's money -- retiree and taxpayer money -- to try to get out from behind the eight-ball? Are there "financially dead" states that go on living by hiding their true financial conditions?
At Truth in Accounting, we have developed a "zombie index" to identify states we believe might be more likely than others to engage in more-aggressive risk-taking. The index is based on three main elements: States with a higher zombie index have higher taxpayer burdens, as measured by Truth in Accounting. They hide a larger percent of debt related to pensions and other retirement benefits. And they lack timeliness in their financial reporting. These factors are similar to the way savings and loans delayed telling the truth with the aid of convenient regulatory accounting principles.
Government asset managers can quickly take on higher investment risk, particularly in derivatives markets. Therefore taxpayers deserve more frequent and robust reporting of investment results. Initiatives in this regard could usefully be part of broader adoption of fact-based budgeting techniques that would make life harder for the walking dead.
VOICES is curated by the Governing Institute, which seeks out practitioners and observers whose perspective and insight add to the public conversation about state and local government. For more information or to submit an article to be considered for publication, please contact editor John Martin.
