Talking about the state of the state, or other states, is caught in a bind between falling tax revenues, decreasing transfers from the federal government, and a growing share of responsibilities for health care and the enforcement of regulation mandated by the United States Congress.

While the falloff in tax revenue in Virginia is not as bad as in many other states, counties and towns in Virginia are making cuts in services while raising taxes and fees.

The argument goes that 2009 and 2010 are unusually bad years, with unemployment high, after tax income falling, housing still on the rocks, and heavy debt weighing on most taxpayers. State and local officials plead for patience, innocently hoping that the return to "normal" is just around the corner.

The hard truth is that the squeeze on local governments will continue for the next several years. The "new normal" pace of economic growth will most likely be much slower than what we became accustomed to before recession began in 2007.

Recent job figures suggest moderate improvement, but to get back to where we were before 2007 will take 5 to 10 years – or even more, there is no quick fix.

In recent months, it has become increasingly apparent that State and local governments face even bigger challenges than previously acknowledged.

In virtually all states and localities, governments traditionally reported revenues and expenditures on a pay-as-you-go basis.

Under that system, liabilities for things like post-employment benefits for retirees were not required to be disclosed, even though they had to be paid.

New accounting standards are now forcing local governments to account for those obligations publicly. For many state and local governments, this will make the size of their budget deficits much larger.

Already, many local governments are considering dramatic cuts in retirement benefits, while a few are even considering bankruptcy to get rid of all post-employment obligations.

The only way to rapidly cut local government spending is to cut payroll and social services.

Continuing cuts in teachers and funding of schools and universities seem inevitable.

Cuts in nonessential services are already under way, but cuts in emergency services such as police officers and fire fighters will also take place.

Cuts in state and local jobs will worsen the unemployment situation and further suppress tax revenues. To fill the budget deficit gaps, virtually every state and local government is planning to increase borrowing.

They will all be competing with a growing flood of federal debt necessary to cope with the enormous US Government deficits.

A new threat is that rating agencies will be looking hard at the rising deficits of state and local governments and their escalating unfunded benefits, with the likelihood that there could be continuing waves of downgrades.

Historically, municipal bonds have an extremely low default rate, but investors will have to pay much closer attention to what municipal bonds they own and buy going forward. It is important to have a strategy in place not only to preserve the value of the portfolio, but also to safely take advantage of rising interest rates when they occur.

Investing locally is virtuous, but it is increasingly necessary to have in depth professional knowledge and vigilance in efforts to safeguard one's capital.

Dr. Harald Malmgren is Global Economic Strategist at Bluemont Capital. For more information, please contact Mark Stys at 540-687-5005 or mstys@bluemontcapital.com