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Wow. Congress wants to prohibit the Fed from bailing out bankrupt states.

Wow. Congress wants to prohibit the Fed from bailing out bankrupt states.

Just days ago, in the midst of the Puerto Rico debt morass, 24 members of Congress introduced the “No Bailouts for State, Territory, and Local Governments Act.”

The title pretty much sums it up.

Congress knows there’s a massive wave of defaults looming at the city and state level.

Detroit and Puerto Rico are just the tip of the iceberg.

Aside from a few top performers like Alaska, South Dakota, and Wyoming (which, ironically, have no state income tax), many US states have atrocious finances.

Illinois and Maine, for example, have dangerously low levels of cash relative to the debts and obligations they have to pay.

Bankrupt states  – NJ, CA?

New Jersey and California have are among several states that are technically insolvent, meaning they lack sufficient assets to make good on all the promises they’ve made (like pensions and bonds).

 

Bankrupt states
Bankrupt states chart via JPMorgan

And as the case of Puerto Rico shows, these fiscal imbalances can become a major crisis. Quickly.

Needless to say, the US federal government is in the exact same boat.

Uncle Sam has the worst finances of the bunch– $19 trillion in debt, $40+ trillion in long-term pension liabilities, and decades worth of budget deficits.

But unlike state governments, the US federal government has an ace in the hole: the Federal Reserve.

Right now the Fed is one of the largest holders of US debt; whenever the US government goes into debt, the Fed essentially bails them out by printing money and buying Treasury bonds.

This convenient relationship with the Federal Reserve has allowed the US government to kick the can down the road for years.

Every time they run a budget deficit and need more cash, the Fed prints money.

But states can’t do that.

They don’t have the ability to conjure money out of thin air like the central bank.

So when they run out of funds and can’t borrow anymore, the natural tendency would be for states to seek a bailout from the US federal government.

That’s what happened in Puerto Rico. The island is in default, and as a US territory, they’ve gone to the federal government with hat in hand.

Of course, the US government is too broke to bail anyone out, including itself.

So this new bill was put on the table to prohibit any federal agency, including the Treasury Department, from bailing out ANY bankrupt city, state, or territory (cough, cough Puerto Rico).

What’s even MORE interesting is that the bill specifically prohibits the Federal Reserve from “financially assisting State and Local governments.”

In other words, the Fed is not allowed to print money to buy bonds issued by city or state governments.

So Congress is basically rigging the system in its favor and telling the Fed, ‘Hey, all that money you print is going to end up in OUR pockets!’

As the most insolvent government of them all, Congress needs all the bailouts it can get, and they can’t afford to have any competition from cities and states.

This pretty much tells you everything you need to know about the financial system:

There is so much debt in the system, and these governments are all so absurdly bankrupt, that Congress proposed a special law to make sure they get to steal 100% of the money that the Federal Reserve is conjuring out of thin air all for themselves.

It’s pure insanity.