Debt is manageable until it is not. That is not a flippant analysis of debt, but is actually the truth about overextended consumers or highly leveraged businesses.
Debt is offered by banks or investors because they believe the borrower will have the ability to repay the money. Financial problems tend to appear suddenly, and when problems develop, debt that was manageable earlier becomes unserviceable.
Consumer lending is often limited by annual income because lenders realize debt must be repaid from income. Sovereign governments issue debt based on gross domestic product (GDP), which implies that the government has a claim to all of a nation's output. This is probably not accurate, but is widely accepted in practice and will remain widely accepted until a crisis develops.
For state and local governments, credit analysis should probably be based on consumer financing standards. Unlike the federal government, states and cities do not claim they can confiscate all of a community's assets to repay debt. By this measure, states and local governments have become overleveraged.
State and local revenue of $2.8 trillion per year is now providing services for residents and covering the costs of servicing $3.1 trillion of debt.
Debt is now 110 percent of annual revenue and unfunded pension and healthcare obligations would make the debt picture significantly worse. One study found that unfunded obligations total $4.1 trillion.
Counting unfunded obligations, state and local government debt totals 257 percent of annual revenue. A small increase in interest rates could bankrupt many towns and cities and create a debt crisis that is even worse than 2008.
© 2013 Moneynews. All rights reserved.