European Lessons for America

by Fred Smith on May 8, 2012

in Bailout Watch, Economy, International

George Will warns that America’s system of competitive federalism is threatened by our own “Greeces.” (“In Illinois the bills are coming due,” April 27). Europe has been brought to its knees by the moral hazard from guaranteeing the debt of imprudent entities. Could a default in Illinois create a similar collapse here? Not in the same way.

States are allowed fiscal autonomy and are expected to suffer the consequences of their own fiscal imprudence. Direct federal bailouts are unlikely, but they are not the real threat.  The risk Illinois raises for America is that the Federal Reserve may decide that states are “too big to fail” and move to ensure that failing states can continue to borrow and carry on their non-sustainable fiscal and regulatory policies.

That is what happened in Europe, as the European Central Bank (ECB) rushed to ensure that Greece could continue spending. The ECB is outside of normal political controls. Finding ways to restrain the Fed may be the primary challenge of the next administration.

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