Fragile recovery: high unemployment, lackluster consumer Demand and an anemic real estate market all spell Continued trouble for state budgets.

• Author: Thornberg, Christopher

The National Bureau of Economic Research tells us the recession ended in June 2009, but you wouldn't know it by looking at state budgets. They're worse, not better.

California, New York and Texas alone face a combined $60 billion budget gap over the next two fiscal years. The public bond markets that up until now have been happy to continue to fund states and local economies are showing the first signs of reluctance. Rates have started to rise.

The reason for this growing crisis is twofold. First, most states failed to enact long-term solutions when the budget gaps first formed at the start of the downturn, instead relying on delay tactics such as one-time revenues and accounting tricks. Although some may call this a dodge, kicking the can down the road a bit isn't necessarily a bad thing. Moving budget problems to better times when revenues are growing spreads out the pain and limits the fiscal sting of higher taxes and reduced spending during the worst part of the economic crisis.

This leads directly to the second reason the problems have grown worse. Those hoped-for better times of growing revenues have not materialized. Although state revenues have started to grow, the pace has been tepid at best. This reflects, in turn, the overall weakness of the current recovery. To put this in perspective, after the last two deep recessions in 1974 and 1982 came to an end, the economy averaged 6.7 percent growth over the five quarters that followed. During the current recovery, the economy has averaged 2.8 percent growth--leaving the economy operating at a level far below its economic potential.

[ILLUSTRATION OMITTED]

CHALLENGES TO GROWTH

When considering contributions to growth at the national level based on where the money is being spent, the growth gaps are clear. Government spending, the trade gap and business spending are right on track to match past recoveries. Residential real estate and consumer spending are responsible for the growth gap.

The reasons behind the lack of consumer spending also are clear, as are the implications for state budgets. During past recoveries there has been a sharp acceleration in consumer spending as households "caught up," buying cars and furniture and other luxuries that were put on hold during the downturn. That isn't happening this time, however, because the recent recession came at the end of a period of unsustainable consumer spending.

[ILLUSTRATION OMITTED]

The rapid rise of asset values in the United States...