Four states are teetering on the edge of failure. These four states make up over 25% of the United States' GDP and are home to over 25% of its population. Their tax revenues have plummeted, and they can no longer afford the spending programs politicians have approved over the past years, even decades.

Technically, there's no legal process by which states can declare bankruptcy. When our country's bankruptcy code was formed, apparently the concept was unthinkable.

So states just muddle on, borrowing more and more to pay their debts (isn't that technically a Ponzi scheme?) while politicians split along party lines so that no one has to ever be held responsible for the dreaded tax hikes or spending cuts. Everything can just sputter along…until it can't.If a state can't pay its bills or make good on its debts, you don't need a bankruptcy judge to tell you there's a big problem. Even if it can't be declared 'bankrupt,' common sense tells you that it's broke, insolvent...failed.


The state, which is the 8th-largest economy in the world, faces a $19 billion deficit. They resorted to paying bills with I.O.U.s last year, and it looks like they're not afraid to do it again.

If things got bad enough, and California just stopped making debt payments, it's likely the world's financial system would get swept up in the inevitable chaos. But no one in the bond community is ready to concede that there's a possibility the state would default. At least not yet.

The unspoken hope is that Washington D.C. would swoop in at the last moment to bail out both debtor and creditor. But the tide may be shifting. Washington may be distancing itself from this implicit guarantee.

Illinois Governor Pat Quinn recently said that during his trip to Washington for the National Governors Association meeting it was made clear to all governors present that they should be fully prepared for less money to come from the federal government than they were hoping for.

And if that's the case, you don't want to be anywhere near these three other ticking time bombs.


By now it's pretty much common knowledge Illinois is broke. And if its politicians aren't all corrupt, they're at least spineless.

Because the state government refused to either raise taxes or cut spending, Illinois simply stopped paying the roughly $4.7 billion in bills it owes to public schools, rehabilitation centers, child care providers, the University of Illinois and other unsecured creditors as of the beginning of July.

The University of Illinois has been stiffed on 45% of its state appropriation this year. Legislators helpfully suggested that the university borrow the money and wait for the state to pay them back.

Lawmakers also decided to just 'stick a pin' in $3.7 billion worth of unfunded pension payments until after November elections. Apparently there's no need for incumbents to take a stand on where they think the $3.7 billion should come from. Borrow it at rates so high that interest payments will add an additional $1 billion to the bill? Or just take it out of the general fund and give the middle finger to every non-pensioned citizen who relies on public schools and state-sponsored social services?

New York

Before the Senate adjourned for its summer vacation, it did manage to put together a spending plan. Unfortunately, it failed to come up with the funds to pay for it. The end result is a $9.2 billion deficit and projections that the country's third-largest state by population could run out of cash by September.

This week, Governor David Paterson called an extraordinary legislative session for New York senators, imploring them to return from their summer vacations to pass a budget that's already 4 weeks overdue.

Nine senators, five democrats and four republicans, didn't bother showing up, so when it became apparent the majority democrats didn't have the 32 votes need to pass the final bill needed to finish the state budget, Patterson had no choice but to end the emergency session.

Regardless, E.J. McMahon, director of the Empire Center for New York State Policy, says, 'The state's 2010-2011 budget, like its deficit-ridden predecessor, shapes up as a flimsy house of cards that could begin to collapse before the year is out.'


Still reeling from the loss of tax revenues generated by the once mighty Ford (NYSE: F), GM and Chrysler, Michigan's lawmakers have been crossing their fingers that the U.S. Congress will cough up $560 million in additional federal money to help them fill their budget deficit. In 2008, Congress passed a bill that made higher Medicaid payments to states especially hard hit by the Great Recession, states just like Michigan.

Unfortunately, it looks like the federal legislation that would have extended payment through 2011 will die before reaching the floor of the U.S. Senate.

Without the $560 million in federal money, Michigan faces ugly cuts to programs covered by its general fund — including universities, health care and tax revenue-sharing payments made to local governments. And if a budget is not approved by October 1, the state faces a total shut down of governmental operations.

These states have the most pressing problems, but there will be plenty of others that will feel the pain from recent economic volatility for years to come.