In the United States, a fiscal crisis is hitting states like Arizona, Illinois, Kentucky, California, Virginia, and Illinois. California has a whopping 56% deficit as a percent of its General Fund Budget according to the Center on Budget and Policy Priorities.

California Cash Crunch

Yahoo!News is reporting California debt rating cut as cash crunch looms.

California’s main debt rating was cut on Wednesday by Standard & Poor’s, which said the government of the most populous U.S. state could nearly run out of cash in March — and another rating cut might follow.

“The big question is, is there any fear they will get downgraded out of investment grade (so) you may have to sell … that’s where I think it would get interesting or hairy,” said Eaton Vance portfolio manager Evan Rourke.

S&P;’s downgrade was overdue because the state’s revenues have been so weak, said Dick Larkin, director of credit analysis at Herbert J. Sims Co Inc in Iselin, New Jersey. “Frankly I can’t understand why it took S&P; so long,” he said. “They could have made that decision back in September.”

Larkin said the three major rating agencies will hold off on more downgrades to California’s credit rating to avoid roiling the municipal debt market, even in the event budget talks between Schwarzenegger and lawmakers drag on.

“They’ll give the state an awful lot of rope,” Larkin said. “For a state to go below investment grade would cast a pall on every state and local issuer out there.”

Rating Game Scam

There is little doubt California should be rated as junk already. Dick Larkin notes they give the states a lot of rope and wonders: “Frankly I can’t understood why it took S&P; so long.”

What takes so long is one of two things, perhaps both.

1. Sheer incompetence by Moody’s, Fitch,and the S&P;
2. The ratings model itself, encourages ridiculously optimistic ratings

The big three rating agencies get paid on the quantity of debt they rate not the quality of their ratings. The higher they rate, the more business they get. For more on the problem as well as what to do about it, please see Time To Break Up The Credit Rating Cartel.

The big three did not downgrade Enron until after it blew up, and held of on downgrades of GM, Ambac, MBIA and others with share prices hovering just above zero.

Until the model changes, we will continue to see this kind of corruption and incompetence, for the simple reason the model is designed to reward corruption and incompetence.

Maybe so.

But, if so, this is not the first time over the last two centuries in which a decade has been lost. And on each of those prior occasions, the stock market “found” itself soon thereafter.

am not the first commentator to discuss the depressing fact that, over the decade ending Dec. 31, the S&P; 500 index produced a loss. Even with dividends added back in, the index lost 15%, or 1.6% on an annualized basis.

But few of those commentators have noted that, depressing as the picture is that is painted by these statistics, the true picture is even worse. That’s because, over the last decade, the Consumer Price index rose by more than 28% — equal to about 2.5% annualized.

This means that at investor who put a lump in a stock index fund at the beginning of 2000, and held it until the end of last year, lost ground at the rate of around 4% per year. What a shock to investors who blithely assumed that ten years were more than long enough to provide assurance that the stock market would outperform inflation.

But investors at the beginning of the decade should have known better. If they had carefully studied the historical record, they would have discovered a number of past ten-year periods in which the stock market produced a negative real return.

The most recent such period was the summer of 1982. According to an analysis I ran on data compiled by Yale Professor Robert Shiller, the stock market’s trailing real return that summer was minus 3.6% annualized. The other “lost” decades that suffered the largest inflation-adjusted losses include the one ending December 1974 (when the trailing ten-year real return was negative 2.7%), August 1939 (when the trailing return was negative 3.3%) and June 1921 (when it was negative 3.1%).

While there is some solace in knowing that the decade we’ve just suffered through is not unprecedented, the good news is that, in each past case since 1870 in which the market’s trailing ten-year return was negative, its inflation-adjusted return over the subsequent ten years was positive.

This has held true even during decades of high inflation, such as the 1970s. Consider an investor who put a lump sum into the stock market in late1974. He would have been well behind inflation during the latter part of that decade, of course, when the consumer price index was rising at double digit annual rates. But, for the full decade through the end of 1984, this investor would have had an inflation-adjusted total return of 5% annualized.

That may be changing, as ETFs finally are gaining a foothold in the 401(k) retirement-plan market.

According to estimates from BlackRock Inc., the largest sponsor of ETFs, investors hold at least $2 billion of its iShares ETFs in 401(k) plans after buying about $500 million in fund shares last year.

Since iShares controls about half the ETF market, the figure suggests that in total there may be something like $4 billion of ETF assets in 401(k)s.

That is just a tiny sliver of the more than $1 trillion in 401(k) assets invested in mutual funds, but it represents significant growth from several years ago, when ETFs were almost entirely absent from these plans.
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Since they mostly track indexes, which don’t tend to turn over much, and often swap stocks instead of buying and selling them, ETFs don’t tend to run up capital gains taxes that are passed along to their investors.

Exchange-traded funds have struggled in the 401(k) market because retirement plans neutralize some of their key advantages.

To keep brokerage commissions low, 401(k) plans typically pool many individual investors’ trades, eliminating participants’ ability to trade all day long. Also, retirement plans already allow investors to avoid capital-gains taxes, making ETFs’ tax benefits moot.

The exchange-traded fund industry has been arguing that ETFs should still be added to plans because of their low costs.

But there is a catch here, too. The 401(k) plans already include low-cost conventional index funds—typically large plans run by big companies—and thus don’t have much reason to switch.

For that reason, BlackRock’s iShares is focusing on small plans, typically those with less than $50 million in assets, says Greg Porteous, director of its 401(k) business.
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Unlike large plans, which often offer mutual funds run by the same company that handles back-office “record-keeping” services for the employer, many smaller plans are overseen by a financial adviser. And as BlackRock points out, financial advisers are often fans of ETFs, making the sale easier than it otherwise might be.

“There’s not a lot not to like,” says Jerry Verseput, a financial planner in El Dorado Hills, Calif. He says he’s researched 401(k) plans recently because he’d like to add retirement-planning segment to his business.

In his experience, Mr. Verseput says, plans that include ETFs have tended to offer more transparent cost schemes and lower costs over all, factoring in both the costs of the funds and the costs to administer the plans.

Unlike other 401(k) options, ETFs don’t accommodate “revenue-sharing,” or using a portion of the fees investors pay to funds to support administrative costs of retirement plans.

Many financial advisers and consumer advocates think that is good news since it makes it easier to keep tabs on what investors are actually paying for.

But it doesn’t necessarily guarantee lower costs: Some plans add separate administrative fees to make up for the money lost from the lack of revenue sharing.