The Next Big Bailout: State and Local Governments

With state and local governments suffering from a steep decline in tax revenues, there's "another S&L crisis" coming, says Diane Garnick, investment strategist at Invesco. And since every crisis deserves its own bailout, get ready for the Federal Government to step in an prop up state and local municipalities, says Garnick, whose firm has about $350 billion of assets under management.

While states like Michigan and California are the most likely candidates for a bailout - especially the former if Chrysler and/or GM files for bankruptcy - other states will be quick to raise a hand if Federal funds are flowing, she says. And even the states in stronger financial position may not have a choice Garnick says, recalling that automakers like Ford and financial firms like Goldman Sachs were compelled to take Federal monies they may not have wanted or needed.

If Washington D.C. similarly tries to avoid "playing favorites" with the states, there are two immediate investing implications of the scenario: 1)Muni bonds are a good investment, especially since yields have risen recently amid fears that declining tax revenues will lead to higher default rates. (A Federal bailout would effectively prevent such a scenario, meaning muni bondholders will get paid -- in full.) 2)The Federal government deficit is going even higher than currently projected. Since most state and local governments are prohibited from running deficits, Washington D.C. will have to go deeper into debt to pay for the "S&L" bailout.