FORTUNE – While the U.S. federal government struggles to gets its finances in order and avoid default, budgets in America's cities and states are improving.
The development is unexpected and a near reversal of the financial strains municipalities went through in the wake of the 2007 financial crisis. Property tax revenue plummeted as home prices collapsed, causing widening budget gaps across several municipal governments. A chunk of President Obama's $787 billion stimulus package rescued cash-strapped states, but that wasn't enough to keep some from predicting financial Armageddon.
In 2011, famed Wall Street analyst Meredith Whitney predicted a wave of as many as 100 municipal bond defaults. Her forecast freaked out investors, but they were left puzzled (and relieved) when that never quite transpired. As it turns out, the muni alarms were misplaced; instead investors should have zeroed in on the federal government as Congress struggles to avoid defaulting on the nation's debt.
True, some cities aren't doing very well at all, such as Detroit and Stockton, Calif. Delaware hasn't gone bankrupt, but it's the only state left that risk falling back into a recession, according to a September report by Moody's Investors Service. Despite the uneven recovery, states and cities generally have bounced back as the job and housing markets slowly improve. California expects to have a budget surplus this year, after multi-billion dollar shortfalls in recent years; Utah is even offering to help the federal government reopen three national parks as the U.S. enters the 11th day of a partial government shutdown Friday.
For 13 quarters in a row, state tax revenues have grown, rising by 8.6% during the first quarter of 2013 from a year earlier, according to an August report by the Rockefeller Institute and the Census Bureau.
Finances across U.S. cities have been healing, too. In a survey of city finance officers by the National League of Cities, 72% say their cities are better able to meet fiscal needs this year than last. It's a stark contrast from 2009, when only 12% of finance offices thought that. During the recession, cities cut spending sharply. As the economy recovered, sales and income taxes have picked up. So have revenues from property taxes -- the result of an improving housing market.
By contrast, the federal government could technically default any week now, although many would say that's unlikely. But some of those people probably also thought the government wouldn't shut down either.
U.S. Treasury Secretary Jack Lew says Congress must raise the nation's borrowing limit by Oct. 17 or else it will have no way to pay its bills and risks defaulting on its debt. Oddly enough, it's not so much that the money isn't there, but rather political stalemate and sniping that has left Americans vulnerable to a default.
Of course, the muni bond alarmists didn't see this coming.
FORTUNE -- When Indiana governor Mitch Daniels announced a budget surplus for the latest fiscal year, the windfall came as good news for his state's employees, some of whom received bonuses of as much as $1,000. Indiana is not alone. An increasing number of states are reporting black ink. The Associated Press reported that 15 ran surpluses for fiscal 2011, up from 10 the year before. Generally, a surplus is MOREFeb 14, 2012 5:00 AM ET
With the passage of new Wall Street reform, states will have some power to catch financial bad guys again.
By Heidi N. Moore, contributor
The Dodd-Frank financial reform bill (should it ever pass) is supposed to be a victory for the little guy. But what few people know is that it's also a victory for the little regulators.
Well, they're not really little; they're the nation's 50 or so state securities regulators. And MOREJun 29, 2010 5:18 PM ET
How ugly are the state budget problems?
Nasty enough that traders are betting that two big U.S. states, California and Illinois, are just as apt to default on their bonds as Portugal -- and almost as likely as Iraq.
The price to insure against a default on Illinois general obligation bonds jumped to an all-time high Thursday. The state, which is facing a deficit that amounts to half its annual budget, has MOREColin Barr - Jun 18, 2010 7:35 AM ET
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