In the U.S., Crisis in the Statehouses

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It's tough to cut the benefits of police officers, firefighters and schoolteachers. But the long recession has cast a glaring light on the fact that public and private workers increasingly live in separate economies. Private-sector employees face frequent job turnover, relentless downsizing, stagnant wages and rising health-insurance premiums. They fund their own retirement through 401(k)s and similar plans, which rise and fall with the tides of the economy. Many public-sector workers, by contrast, enjoy relative job security, and the number of government jobs rose even as the overall unemployment rate shot just past 10%.

B Is for Bankruptcy

The crash of 2008 has also left some civic leaders with eggy faces and possibly worse. In Georgia, at least a dozen Atlanta-area municipalities and agencies embraced the "exotic, high-risk derivative securities" called swaps in hopes of lowering the cost of bond issues, according to an investigation by the Atlanta Journal-Constitution . They paid nearly $300 million in fees for the privilege to such investment banks as Goldman Sachs, JPMorgan and UBS. Then, when the deals went sour, the same governments paid another $100 million to cancel them.

Busted swaps led to even more dire consequences in Birmingham, Ala. Former mayor Larry Langford was sentenced in March to 15 years in federal prison for bribery in a pay-for-play scheme involving sewer-bond swaps in 2002 and 2003. That debt was only a part of a municipal spending spree for a domed stadium, transit improvements and a scholarship program worthy causes, perhaps, but now unaffordable in a city where a sky-high sales tax of 10%, even on food, has failed to produce the anticipated revenue. New mayor William Bell is trying to mop up, proposing a 10% wage cut for city workers, closing libraries and recreation centers and canceling a city program to provide laptops for grade-school students. As for sewer rates: they have quadrupled, and there's speculation that Birmingham is headed for bankruptcy.

In sun-drenched San Diego, meanwhile, a grand jury probing that city's troubled finances found a recurring practice of skipping required payments to the city's pension fund while simultaneously awarding ever more generous pensions to public employees. Legal? Apparently. Prudent? Nope. A once solvent system is now billions of dollars in the red. The grand jury raised a scarier question: Is San Diego still a "viable" financial entity?

Indeed, the B word has crept into so many conversations in communities around the country that a number of investors are worried that municipal bonds have become the latest debt-fueled bubble ready to burst. California's public-employee unions are lobbying for a bill to ban government bankruptcies entirely, so worried are they about the possibility of widespread defaults to escape pension obligations. Perhaps more worrisome, though, is the risk that all this calamity will ultimately produce little in the way of lessons learned. States are already barred from formal bankruptcy, so although many of them are broke, somehow given enough time they will make ends meet. But will they do it only by tweaking taxes and killing innovative programs like Kentucky's juvenile drug courts, which spend money up front on aggressive intervention and rehabilitation programs in hopes of saving the long-run expense of ruined lives in costly prisons? "It always will cost us more to remove [addicted criminals] from their communities and incarcerate them for years," says District Judge Brandy Oliver Brown of Clark and Madison Counties, whose program of intensive drug testing and counseling will be shuttered by budget cuts. In Harrisburg, Pa., the city council needs to make $68 million in debt payments, mostly related to a mismanaged deal to modernize a trash-burning power plant, when the total city budget is about $60 million. A consulting firm has some ideas: freeze pay, furlough workers, double the property tax, sell city landmarks, artifacts and museums. In one Ohio county, a local judge urged citizens to carry a gun because the sheriff's department was laying off half its deputies.

A few leaders have their sights set higher, trying to shape this crisis into a moment for significant government reform. Governor Jennifer Granholm of Michigan, a state devastated by the shrinking of the American auto industry, has called for an efficiency revolution. She has cut unneeded departments, sold excess state property and killed hundreds of obsolete boards and commissions. Having risen to power in 2002 on the shoulders of the state teachers' union, Democrat Granholm this year successfully pushed a plan to coax thousands of senior teachers into retirement, to be replaced by a smaller number of younger teachers earning less generous but more sustainable benefits. "The 21st century economy is all about speed, access, intelligence and efficiency," Granholm said in announcing her latest round of restructuring. "A 21st century government needs to be about the same things."

Indiana Governor Mitch Daniels, a budget czar in the free-spending Bush Administration, has proved an efficiency fiend at the state level, privatizing bureaucracies, selling a poorly managed toll road, even harvesting the paper clips from state tax returns for reuse in government offices. Daniels took the controversial step of decertifying Indiana's public-employee unions, a move that may endear him to Republican voters should he decide to run for President in 2012.

Modernizing government is no less painful than globalizing industry has been. Consider the proposal by Nebraska state senator Rich Pahls to merge many of the state's 93 counties. The idea could mean boarding up stately old courthouses while forcing consolidation of such services as road maintenance, vehicle registration, even sheriffs' offices and many of the jobs that go with them. The bill died, in part because it seemed too frank an acknowledgment of the passing of small-town America. Yet surely its time will come: only 16 of the counties have more than 20,000 residents, and two are home to fewer than 500 people each. "I tell these people, You don't ranch or farm the way they did 100 years ago," says Pahls. "A ranch might have had 20 hands, and now they have four. They didn't stay behind the technology."

The great reckoning of 2010 took us years to create and will be years in the fixing. It's not as if the economic crisis isn't plenty painful already. In government, as in life, there are cuts that injure and cuts that heal. As they continue to slog through the wreckage of the Great Recession, state and local leaders have a challenge to be surgeons rather than hacks and make this era of crisis into a season of fresh starts.

With reporting by Hilary Hylton / Austin, Texas; Bonnie Rochman / Charlotte, N.C.; Christopher Maag / Cleveland; Karen Ball / Kansas City, Mo.; and Elizabeth Dias and Katy Steinmetz / Washington

Time.com

In the U.S., Crisis in the Statehouses

Schools, health services, libraries and the salaries that go with them are all on the chopping block as states and cities face their worst cash squeeze since the Great Depression