With Christmas shoppers out in force and the stock market surging to a two-year high, talk is spreading that the long-awaited recovery is at hand.

Perhaps.

But gleaning the news from Europe and Asia as U.S. cities, states and the federal government sink into debt, it is difficult to believe a worldwide financial crisis that hammers governments, banks and bondholders alike can be long averted. Consider.

Fitch and Moody’s have just downgraded the debt of Ireland, Greece, Portugal and Hungary. In Budapest, the politicians talk of default. Spain has been warned its debt and banks could be downgraded.

The European Central Bank is buying up this paper to prevent panic selling by investors. There is talk of forcing bondholders to take a haircut. They would trade their suspect bonds for new euro bonds whose face value would be appreciably less.

In the Latin American debt crisis, the United States bailed out its banks holding the bad paper by giving them U.S.-backed bonds, while forcing them to take a loss on their Latin bonds. Courtesy of Uncle Sam, Latin America walked away from a huge slice of its debt.

The Japanese national debt is slated to pass 200 percent of gross domestic product this year, highest of any major economy on earth. Half of Japan’s spending is now financed by bonds. Tax revenues do not even cover 50 percent.

Nor is America out of the woods.

Financial analyst Meredith Whitney told “60 minutes” we can expect 50 to 100 cities and counties to default on their municipal bonds. Though derided as an alarmist, Whitney was among the few who warned that U.S. banks were in treacherous waters before 2008.

If anyone is an alarmist, it is The New York Times. In an editorial the day after Christmas, “The Looming Crisis in the States,” the Times writes, “Illinois, California and several other states are at increasing risk of being the first states to default since the 1930s.”

California and Illinois are to America what Germany and Spain are to the European Union—the first and fifth largest states.

Illinois, writes the Times, “is faced with $4 billion in overdue payments.” The state “has lacked the money to pay its bills. Some of its employees have been evicted from their offices for nonpayment of rent, social service groups have laid off hundreds of workers while waiting for checks, pharmacies have closed for lack of Medicaid payments.” Illinois is also still borrowing to finance half of its budget.

By Sept. 30, the U.S. government will have run three straight deficits of close to 10 percent of GDP. And Barack Obama and the GOP just passed $858 billion in new and extended tax cuts and fresh spending.

Yet many dismiss the threat of a series of defaults by European nations and U.S. states and cities leading to a financial crisis that could eclipse the one we have just passed through.

What is the basis of this confidence?

Germany dominates the European Central Bank and will not allow defaults by Ireland, Portugal, Greece or Spain. For that would imperil the One Europe project to which Germany has been dedicated since World War II. Berlin will do what is necessary to save the euro and prevent Europe’s monetary union from collapse.

What is wrong with this thesis is that it is not Germany alone that decides on defaults. The weaker countries in the euro zone, like Greece, may decide they will not endure the agonies of austerity any longer. Street politics may force regimes to abandon the regimens imposed upon them as a condition of their bailouts.

In America, it is the Fed that is the last line of defense and has shown a disposition to act in a financial crisis.

Since 2008, it has doubled the money supply and taken a trillion dollars in bad debt off the books of U.S. banks. Secretly, it has lent trillions to banks and businesses all over the world and is now buying U.S. bonds to inject more dollars into the economy.

But how does the Fed prevent a state like Illinois from failing to meet its debt obligations and defaulting? How does the Fed prevent a series of municipal bond defaults by cities and counties that lack the tax revenue to pay their bills and whose credit rating has reached a junk-bond status where they can no longer borrow?

Congress would have to vote the bailout money. But will a House that owns its majority to the Tea Party approve half a trillion dollars to bail out Democratic-run cities or Obama’s home state or Jerry Brown’s California?

This June, the stimulus money runs out, and as housing prices continue to fall across America, property tax revenue will fall.

The Feds are about to stop bailing out the states, and the states, on shortening rations, will stop bailing out counties, cities and towns.

We may be closer to the falls than we imagine.

COPYRIGHT 2010 CREATORS.COM

Share This