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State governments face one of corporate America's biggest problems: Extra cash

March 27, 2013: 11:14 AM ET

States expect modest budget surpluses this year, and just like U.S. companies, they're not exactly loosening their purse strings.

121128051557-cash-gift-monsterFORTUNE -- To save or spend?

It's a question corporate America has been grappling with, even as companies sit on monstrous levels of cash. Now states are facing a similar conundrum: With home prices rising and local tax revenues rebounding, places like California and Florida that not long ago feared going bankrupt expect to see modest budget surpluses this year.

The extra cash is obviously a welcome surprise. As The Wall Street Journal recently reported, states are collectively raising their cash reserves close to healthy levels. Altogether, they're expected to increase reserves by $3.4 billion to $41.4 billion in the fiscal year that, for most states, ends June 30. That equals roughly 9% of state revenue -- a level not seen since 2008 and a marked improvement from the lowest point of 5.2% in 2010.

But states aren't exactly loosening their purse strings. Years of tough economic times have led lawmakers to wonder if it would be wiser to save the extra cash for emergencies rather than spend it to preserve jobs and bolster the economy. Their predicament is not all that different from what CEOs at the nation's biggest companies are going through. Albeit on a much grander scale, companies have been hoarding cash at record levels since the dark days of The Great Recession. Critics have urged companies to use their extra cash to hire more and help spur the economy. But little, if anything, has changed.

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As of the third quarter of 2012, nonfinancial corporations in the U.S. have held $1.7 trillion of cash and securities that could easily be converted to cash, according to the Federal Reserve. By any measure, this is high. Historically, nonfinancial corporations held liquid assets of 25% to 30% of their short-term liabilities. That share grew in 2001 to a range of 40% to 50%. And as of the third quarter of 2012, the percentage was close to 50%.

Much of this cash is parked outside of the United States. Although several factors explain the rise in cash levels, uncertainty over federal taxes and spending policies along with the future of the economy are obvious reasons. If by chance the economy stalls again, executives may have a hard time getting credit on short notice. And so the extra cash serves as a cushion.

Similarly, states collecting more tax dollars are trying to build a safety net. One particular place doing so, the Journal notes, is Michigan. While the unemployment rate, at 9%, is well above the national average of 7.7%, the state has continued replenishing its rainy-day fund in case the economy or something else goes terribly wrong. The fund was at $2.2 million in January 2011, but is expected to grow to $505 million by the end of this fiscal year.

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To be sure, it's highly unlikely that states would see cash reserves rise to the levels seen with corporations. After all, they don't operate in the free market. Governments have laws limiting the level of reserves they can accumulate. There are also limits to how much states can tax. What's more, unlike corporations, many states are legally obligated to keep their rainy-day fund at a certain level. Part of the build-up in state reserves reflects efforts to replenish their reserves according to state laws.

"My experience is they will find a balance," says Jessica Blume, vice chairperson and U.S. public sector leader for Deloitte, a consultancy. "You don't know when the next hiccup is coming."

Nonetheless, the fact that a debate is brewing over whether to save or spend says a lot about the economy. It's certainly recovering but not enough to ease the jitters of states still recovering from the recession.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

Email | @ninhaitseng | RSS

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