Boomerang: Travels in the New Third World (19 page)

The night is young and the Reeperbahn is hopping: it’s the closest thing I’ve seen in Germany to a mob scene. Hawkers lean against sex clubs and sift likely customers from the passing crowds. Women who are almost pretty beckon men who are clearly tempted. We pass several times the same corporate logo, of a pair of stick figures engaged in anal sex. Charlotte spots it and remembers that a German band, Rammstein, was arrested in the United States for simulating anal sex on stage while performing a song called “
Bück
Dich” (Bend Over). But on she charges, asking old German men where to find the dirt. At length she finds a definitive answer, from a German who has worked here for decades. “The last one shut down years ago,” he says. “It was too expensive.”

V

TOO FAT TO FLY

O
n August 5, 2011, moments after the U.S. government watched a rating agency lower its credit rating for the first time in American history, the market for U.S. Treasury bonds soared. Four days later, the interest rates paid by the U.S. government on its new ten-year bonds had fallen to the lowest level on record, 2.04 percent. The price of gold rose right alongside the price of U.S. Treasury bonds, but the prices of virtually all other stocks and bonds in rich Western countries went into a free fall. The net effect of a major U.S. rating agency’s saying that the U.S. government was less likely than before to repay its debts was to lower the cost of borrowing for the U.S. government and to raise it for everyone else. This told you a lot of what you needed to know about the ability of the U.S. government to live beyond its means: it had, for the moment, a blank check. The shakier the United States government appeared, up to some faraway point, the more cheaply it would be able to borrow. It wasn’t exposed yet to the same vicious cycle that threatened the financial life of European countries: a moment of doubt leads to higher borrowing costs, which leads to greater doubt, and even higher borrowing costs, and so on until you become Greece. The fear that the United States might actually not pay back the money it had borrowed was still unreal.

On December 19, 2010, the television news program
60 Minutes
aired a thirteen-minute piece about U.S. state and local finances. The correspondent Steve Kroft interviewed a private Wall Street analyst named Meredith Whitney, who, back in 2007, had gone from being obscure to famous when she correctly suggested that Citigroup’s losses in U.S. subprime bonds were far bigger than anyone imagined, and predicted the bank would be forced to cut its dividend. The
60 Minutes
segment noted that U.S. state and local governments faced a collective annual deficit of roughly half a trillion dollars, and noted another trillion-and-a-half-dollar gap between what the governments owed retired workers and the money they had on hand to pay them. Whitney pointed out that even these numbers were unreliable, and probably optimistic, as the states did a poor job of providing information about their finances to the public. New Jersey governor Chris Christie concurred with her and added, “At this point, if it’s worse, what’s the difference?” The bill owed by American states to retired American workers was so large that it couldn’t be paid, whatever the amount. At the end of the piece Kroft asked Whitney what she thought about the ability and willingness of the American states to repay their debts. She didn’t see a real risk that the states would default, because the states had the ability to push their problems down to counties and cities. But at these lower levels of government, where American life was lived, she thought there would be serious problems. “You could see fifty to a hundred sizable defaults, maybe more,” she said. A minute later Kroft returned to her to ask her when people should start worrying about a crisis in local finances. “It’ll be something to worry about within the next twelve months,” she said.

That prophecy turned out to be self-fulfilling: people started worrying about U.S. municipal finance the minute the words were out of her mouth. The next day the municipal bond market tanked. It kept falling right through the next month. It fell so far, and her prediction received so much attention, that money managers who had put clients into municipal bonds felt compelled to hire more people to analyze states and cities, to prove her wrong. (One of them called it “The Meredith Whitney Municipal Bond Analyst Full Employment Act.”) Inside the financial world a new literature was born, devoted to persuading readers that Meredith Whitney didn’t know what she was talking about. She was vulnerable to the charge: up until the moment she appeared on
60 Minutes
she had, so far as anyone knew, no experience at all of U.S. municipal finance. Many of the articles attacking her accused her of making a very specific forecast—as many as a hundred defaults within a year!—that had failed to materialize. (Sample Bloomberg News headline:
MEREDITH WHITNEY LOSES CREDIBILITY AS MUNI DEFAULTS FALL
60%
.) The whirlwind thrown up by the brief market panic sucked in everyone who was anywhere near municipal finance. The nonpartisan, dispassionate, sober-minded Center on Budget and Policy Priorities, in Washington, D.C., even released a statement saying that there was a “mistaken impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown.” This was treated in news accounts as a response to Meredith Whitney, as she was the only one in sight who could be accused of having made such a prediction.

But that’s not at all what she had said: her words were being misrepresented so that her message might be more easily attacked. “
She was referring to the complacency of the ratings agencies and investment advisers who say there is nothing to worry about,” said a person at
60 Minutes
who reviewed the transcripts of the interview for me, to make sure I had heard what I thought I had heard. “She says there is something to worry about, and it will be apparent to everyone in the next twelve months.”

Whatever else she had done, Meredith Whitney had found the pressure point in American finance: the fear that American cities would not pay back the money they had borrowed. The market for municipal bonds, unlike the market for U.S. government bonds, spooked easily. American cities and states were susceptible to the same cycle of doom that had forced Greece to seek help from the International Monetary Fund. All it took to create doubt, and raise borrowing costs for states and cities, was for a woman with no standing in the municipal bond market to utter a few sentences on television. That was the amazing thing: she had offered nothing to back up her statement. She’d written a massive, detailed report on state and local finances, but no one except a handful of her clients had any idea what was in it.
“If I was a real nasty hedge fund guy,” one hedge fund manager put it to me, “I’d sit back and say, ‘This is a herd of cattle that can be stampeded.
’
”

What Meredith Whitney was trying to say was more interesting than what she was accused of saying. She didn’t actually care all that much about the municipal bond market, or how many cities were likely to go bankrupt. The municipal bond market was a dreary backwater. As she put it, “Who cares about the stinking muni bond market?” The only reason she had stumbled into that market was that she had come to view the U.S. national economy as a collection of regional economies. To understand the regional economies, she had to understand how state and local governments were likely to behave; and to understand this she needed to understand their finances. Thus she had spent two unlikely years researching state and local finance. “I didn’t have a plan to do this,” she said. “Not one of my clients asked for it. I only looked at this because I needed to understand it myself. How it started was with a question: how can GDP [gross domestic product] estimates be so high when the states that outperformed the U.S. economy during the boom were now underperforming the U.S. economy—and they were twenty-two percent of that economy?” It was a good question.

From 2002 to 2008, the states had piled up debts right alongside their citizens’: their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever-riskier assets. In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it all off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could only be dealt with in one of two ways—massive cutbacks on public services or a default—or both. She thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely.
“The scary thing about state treasurers,” she said “is that they don’t know the financial situation in their own municipalities.”

“How do you know that?”

“Because I asked them!”

All states may have been created equal, but they were equal no longer. The states that had enjoyed the biggest boom were now facing the biggest busts. “How does the United States emerge from the credit crisis?” Whitney asked herself. “I was convinced—because the credit crisis had been so different from region to region—that it would emerge with new regional strengths and weaknesses. Companies are more likely to flourish in the stronger states; the individuals will go to where the jobs are. Ultimately, the people will follow the companies.” The country, she thought, might organize itself increasingly into zones of financial security and zones of financial crisis. And the more clearly people understood which zones were which, the more friction there would be between the two. (“Indiana is going to be like, ‘NFW I’m bailing out New Jersey.
’
”) As more and more people grasped which places had serious financial problems and which did not, the problems would only increase. “Those who have money and can move do so,” Whitney wrote in her report to her Wall Street clients, “those without money and who cannot move do not, and ultimately rely more on state and local assistance. It becomes effectively a ‘tragedy of the commons.
’
”

The point of Meredith Whitney’s investigation, in her mind, was not to predict defaults in the municipal bond market. It was to compare the states to each other so that they might be ranked. She wanted to get a sense of who in America was likely to play the role of the Greeks, and who the Germans. Of who was strong, and who weak. In the process she had, in effect, unearthed America’s scariest financial places.

“So what’s the scariest state?” I asked her.

She only had to think for about two seconds.

“California.”

AT SEVEN O’CLOCK
one summer morning I pedaled a five-thousand-dollar titanium-frame mountain bike rented in anxiety the previous evening down the Santa Monica beach road to the corner where Arnold Schwarzenegger had asked me to meet him. He turned up right on time, driving a black Cadillac SUV with a handful of crappy old jalopy bikes racked to the back. I wore the closest I could find to actual bicycle gear; he wore a green fleece, shorts, and soft beige slipperlike shoes that suggested both a surprising indifference to his own appearance and a security in his own manhood. His hair was still vaguely in a shape left by a pillow, and his eyelids drooped, though he swore he’d been up for an hour and a half reading newspapers. After reading the newspapers, this is what the former governor of California often does: ride his bike for cardio, then hit the weight room.

He hauls a bike off the back of the car, hops on, and takes off down an already busy Ocean Avenue. He wears no bike helmet, runs red lights, and rips past
DO NOT ENTER
signs without seeming to notice them, and up one-way streets. When he wants to cross three lanes of fast traffic he doesn’t so much as glance over his shoulder but just sticks out his hand and follows it, assuming that whatever is behind him will stop. His bike has at least ten speeds but he has just two: zero, and pedaling as fast as he can. Inside half a mile he’s moving fast enough that wind-induced tears course down his cheeks.

He’s got to be one of the world’s most recognizable people, but he doesn’t appear to worry that anyone will recognize him, and no one does. It may be that people who get out of bed at dawn to jog and Rollerblade and race-walk are too interested in what they are doing to break their trance. Or it may be that he’s taking them by surprise. He has no entourage, not even a bodyguard. His economic adviser, David Crane, and his media adviser, Adam Mendelsohn, who came along for the ride just because it sounded fun, are now somewhere far behind him. Anyone paying attention would think, That guy might look like Arnold but it can’t possibly be Arnold because Arnold would never be out alone on a bike at seven in the morning, trying to commit suicide. It isn’t until he is forced to stop at a red light that he makes meaningful contact with the public. A woman pushing a baby stroller and talking on a cell phone crosses the street right in front of him, and does a double take. “Oh . . . my . . . God,” she gasps into her phone. “It’s Bill Clinton!” She’s not ten feet away but she keeps talking to the phone, as if the man is unreal. “I’m here with Bill Clinton.”