Sour Times for Cities

Two things concerning cities we learn more about almost every day…the sad state municipal finances…and the efforts some cities or educational systems have used to keep the spending going.

A real shocker is the piece by Gillian Tett in the Financial Times on Friday.  

“The issue at stake revolves around some exotic bonds issued by San Diego educational authorities in recent years…as the fiscal situation in California has deteriorated, voters have become so upset they have imposed various fiscal straitjackets on educational boards. Worse, property tax revenues, which have been used to fund schools, have declined as the housing market has crashed.

That has left schools in a bind. So, local financial advisers have offered some “innovative” solutions. Last year, Poway Unified, one San Diego educational district, issued some $105m worth of “capital appreciation” bonds to finance previously planned investment projects.

These are similar to zero-coupon bonds, meaning the district does not need to start repaying interest or capital until 2033.

As a result, Poway’s local authority has been able to promise to keep local taxes unchanged while completing previously promised investments (building projects, computers and so on).

But, there is a big catch: to compensate for this payment deferral, these bonds are paying highish (7 per cent) interest rates and cannot be redeemed early. When the bond is repaid in 2051, the total bill will be more than 10 times the initial loan.”

Furthermore, we read on the front page of the Wall Street Journal that "Hard Times Spread for Cities".

“Fiscal woes that have caused high-profile bankruptcies in California are surfacing across the country as municipalities struggle with uneven growth and escalating health and pension costs following the worst recession since the 1930s.

Budget crunches already have prompted Michigan lawmakers to authorize emergency fiscal managers, and led the mayor of Scranton, Pa., to temporarily cut the pay of all city workers to the minimum wage.

In a majority of the nation's 19,000 municipalities—urban and rural, big and small—stagnant property tax revenues, less aid from states and rising costs are forcing less dramatic but still difficult steps.

Moody's Investors Service recently said that while municipal bankruptcies are likely to remain rare, it warned of a "a small but growing trend in fiscally troubled cities unwilling to pay their debt obligations.’"

In fact, Moody's just downgraded nearly 300 US municipal issuers in the second quarter.  Moody’s analyst Dan Steed stated that “With potential federal fiscal cuts looming and state cost pressures in the areas of healthcare and underfunded pensions, the credit outlook for the state sector remains negative.”

Cities…and states…have a long way to go to get out of their financial straits.  I have  written over and over in this blog that the United States economy has to go through a substantial amount of restructuring in order to return to  condition in which more normal growth patterns can be achieved. 

The list goes on and on…local governments have unfunded pension liabilities that total around $3 trillion…unfunded health benefit liabilities total in excess of $1 trillion…state and local spending fell by an annual rate of more the 2 percent in the second quarter…and local governments have cut more that 66,000 jobs in the past year, mostly teachers and other school employees. 

And, this restructuring will continue into the future. 

Furthermore, universities and colleges, a big part of state and local budgets, are not immune from the restructuring that is going on.  One can also add to this the role that information technology will play in this restructuring of education.

The economy is growing…my forecast for the near future is around a 2 percent year-over-year rate of growth in real GDP. 

I do not see how the growth rate can be much higher than this over the next couple of years given the huge structural dislocations that exist within our economy.  Before our economy can resume a more normal growth rate of around 3.2 percent, the economy is going to have to do a lot of restructuring.

A lot of the problems in the realm of state and local governments come from one source that is going to have to be dealt with in the future and that is the strength of public unions.  Right now, public unions make up more than 50 percent of the unionized workers in the United States.  The non-public unions having been declining for many years as the economy has shifted from manufacturing-based industry to service-based.  Their day is past. 

Now, this is happening for the public unions.  The “piggy bank” of the public unions, property taxes, have plummeted in recent years and are not seen as returning to the lush years of the 1990s and 2000s for quite some time…if at all.

In essence the old “war” between labor and capital is waning…but there is something new coming to replace it.  This something “new” is the bifurcation of American society…not between employer and employee…but 

between those that are grow up in the world of the 21^st century and those that are not prepared either in lifestyle or education to succeed in the current work environment. 

Recent figures show that there are just under 4 million jobs that are going unfilled because employers can’t find people with the appropriate skills to fill these jobs.  The under-employment rate I estimate to be about 20 percent of the eligible workforce. 

And, there is more and more research highlighting the severe separation along these lines that is growing in the United States. 

These problems are not going to be solved overnight.  These problems take years…and into decades…to resolve. 

State and local governments must adapt.  Now that their “piggy bank” has been taken away from them they must change.  But, this will be slow…and will be very painful.  This, however, is the future.  Don’t get too excited about the recovering economy without considering these facts.