Well, here's a shocker, my home state of Illinois just got a downgrade from Moody's. The bottom line is that those bastards in Springfield (our capital) still haven't done anything about the $11 billion budget gap. All we do is spend spend spend, and it isn't even all on good projects. We recently saw a spat of construction jobs, but it isn't on any of the scale that is needed, nor mostly on projects that were needed. And yes, there are stories of the usual corruption. Folks here are royally pissed, and all we see is more taxes going up, not to mention fees. I won't even get into Cook County and it's corrupt nepotistic President!

Actually, this isn't really news, as Fitch in July downgraded Illinois' debt as well. But lets understand here what this all means. Because what is happening here is also happening in places like California and other states. A downgrade will make it more costly to borrow money. Investors, primarily large institutional types like pension funds, well they want a high return for the added risk. And this is exactly what a downgrade is for the most part, new or "upgraded" risk.

CHICAGO (Reuters) – Moody's Investors Service on Tuesday downgraded Illinois' general obligation bond rating to A2 from A1, citing the state's financial woes stemming from the U.S. recession.

Moody's cut other Illinois ratings, affecting about $24 billion of outstanding debt, including the state's Build Illinois sales tax revenue bonds, also cut to A2 from A1.

The downgrade gave Illinois the second lowest U.S. state rating from Moody's, with California having the lowest at Baa1, a Moody's spokesman said.

Moody's said Illinois has yet to take action to tackle a structural budget gap of more than $11 billion, equal to about 35 percent of its expenditures.

- excerpt from : "Moody's downgrades Illinois debt ratings", copyright 2009, Reuters

Yet something tells me that at the end of the day, DC won't let the this state or any state for that matter go belly up. Politically that would be a nightmare.  And the local economies, already hurting, would also take a severe beating.  But then we run into a very sticky situation.

Can the federal government, given it's debt load, afford to absorb these liabilities?  Because any bailouts will be from borrowed money from our creditors, don't kid yourself there isn't enough tax revenue on the federal side.  Once more, politics entering the picture, would the Obama Administration make the states that get this money be forced to make "adjustments"? I highly doubt that anything substantial would really be done outside of a few hollow promises.  State government is dominated by unions, and if they have to cut, there will be a price to pay come election time.  So does this mean we end up with some viscious cycle?  Something has to give!

You can raise taxes, even if you went to Eisenhower rates, it still may not be enough.  You can borrow, but eventually (and this is my fear) America's rating will take a hit. Markets ranging from treasuries to equities, from New York to London, would respond in a not-so-kind manner. 

No, as many on this site have warned, this will not end well. Our economy, despite a few "gains" is still one sick patient. And now these "failed states" may act as a new wall towards recovery.