Municipal Finance

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14
Jun 11

Financially Malled

An inside page item in last week’s Wall Street Journal caught my attention:  Faded Malls Leave Cities in the Lurch. The article focuses on the recession’s effect on retailers and the decline of sales tax revenues affecting municipal budgets.   What we have is another cautionary tale about overly optimistic spending on urban malls.  Apparently, retailers have been willing to build even in the face of a glut in retail space, and now they are suffering the consequences.

A Litany of Woe

Sales tax receipts account for 23% of all state and local tax collection.  Unfortunately, in 6 of the last 10 years municipalities have witnessed worsening declines in this revenue source, with a decline of 6.6% in 2009 and 5% in 2010.    Much as experts would love to blame this sad state of retail affairs on the bad current economy, the facts of the decline may go much deeper and last longer:

…it is problem that will persist after a recovery, as demand for retail complexes is whittled by online shopping and the waning popularity of the big-box store selling everything from groceries to electronics.

“I am not sure cities can go back to playing the retail game the way they have over the past 25 years,” said William Fulton, mayor of Ventura, Calif., and editor of the California Planning and Development Report newsletter.  See Faded Malls Leave Cities in the Lurch

Neighboring cities have engaged in dysfunctional escalating competitions to build ever bigger malls.  To entice owners, cities have offered sales tax revenue sharing agreements, real estate tax abatements, development bonds with municipal guarantees and infrastructure improvement such as roads, and exit ramps from highways.

This largesse is now catching up with cities faced with worsening budget shortfalls.  In one example, Independence, Missouri, has used public funds to make a $3.5m debt payment for a local mall. It expects to make another $4m payment this year.  Plus, the city was forced to lay off and furlough employees to fund these payments.  In another case, Tracy, California, is paying Macy’s $2.7m to move into a local mall, this to prevent the mall from closing altogether for lack of an anchor store.

Goldilocks and the Wolves

Financial media trumpeted the 2000’s as the decade of the “goldilocks economy”: a virtuous cycle where low interest rates spurred the growth in the housing market, and then, derivatively, gains in other industries as well: mortgage bankers, investment bankers, second mortgage lenders, attorneys, appraisers, appliance dealers, builders etc.  Sales tax revenues increased, municipal budgets expanded, municipal workers hired and generous wage, pension and other benefit increases flowed.   The Federal Reserve not only spurred this cycle with low interest rates but kept them too low for too long.  This party continued unabated until the economy hit the wall in 2008.

The Wall Street Journal article failed to complete the story of the malls and municipal finance.  Not only are malls in trouble, but the homeowners who shop in them are in trouble. The two failing markets are symbiotically intertwined.  Foreclosures and falling prices only cut real estate taxes and collections.  The municipalities who extrapolated out endless prosperity now suffer the aftermath: insufficient revenues to make bond payments, obligations under union contracts for wage increases, and underfunded pensions, and active and retired health care liabilities.  The “virtuous cycle” of the “goldilocks economy” is now pernicious with a downward spiral of increased fees, reduced services and threatened defaults.

Finally, the article begs the question of what should be the proper role for government.  We can argue about whether it is to secure individual freedoms and rights, or to ensure the safety of the citizenry. Philosophy aside,  I would argue that government has no legitimate role in incenting shopping mall construction or wooing mall tenants.  Revenue sharing deals, tax rebates, infrastructure improvements and other incentives seem to transcend the proper role of government. Private entrepreneurship is just that, private.

The Wall Street Journal item is just one microeconomic issue in our post financial crash economy. Unfortunately, there are many more stories to tell like the follies of the mall.

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9
Mar 11

As Camden Goes, So Goes the USA?

The New York Times reported Monday on the police cutbacks in Camden, New Jersey:

…after the layoffs of 163 police officers, Camden is feeling the impact. Callers to 911 who report things like home burglaries or car break-ins are asked to file a report over the phone or at police headquarters; officers rarely respond in person. “If it doesn’t need a gun and a badge at that location,” officers are not sent, the city’s police chief, J. Scott Thomson, said last week.

Residents have taken their own precautionary measures….Police headquarters now sits nearly empty, its front reception window sometimes closed, as most of the department’s staff has been pushed onto the street for patrol duty. Detectives cannot devote as much time to investigations; a widely praised bicycle unit was disbanded.  Even the canine unit lost two of its three dogs.

It is too early to tell if the police layoffs have allowed more crime to occur; in the first two months of 2011, there were fewer homicides than during the same period last year. But the number of assaults involving a firearm has more than tripled to 79 from 22 over that period. See Police Force Nearly Halved, Camden Feels Impact

A Scary Place to Live

Camden was my home in 1971 and 1972.  Even then it was a crime-ridden, troubled city.  The last downtown department store closed the day I moved in.  There were no local supermarkets, all commerce ended at 5 PM, and the streets were deserted after dark.  I routinely drove to the closest market, eight miles away in Cherry Hill.  This was always a minor adventure, as I never knew if parts of my car would be gone when I reached it.  It was a scary place.

Unlike some other major cities, Camden has the advantage of major employers within its city borders: Campbell Soup Headquarters, Cooper University Hospital, The Delaware River Port Authority, Lockheed Martin, The New Jersey State Aquarium and the Rutgers University Camden Campus.  Despite this roster, this city of 80,000 has 52% of   its residents living in poverty, the highest in the nation.  Recently, Camden has been classified as the most dangerous US city to live in.  It is plagued with drug trafficking, prostitution, street gangs, robbery, looting and homelessness.  See City of Ruins

A Cautionary Tale

Unfortunately, Camden is the ugly urban visage of post-industrial America.  Once a thriving city with thousands of good paying manufacturing jobs in ship building, electronics and food, the city has become an urban wasteland.  What went wrong?

-          Corruption – Within the past twenty years three mayors have been sent to prison. Members of the police department have also been sent to prison for planting evidence, invalidating hundreds of arrests and convictions.

-          Public Sector Bargaining – Faced with job cuts or give backs, the police union voted against unpaid furloughs and instead opted a massive layoff:

In a 300-1 vote, the union rejected an offer that that would have saved 100 jobs. That offer called for three days a month of unpaid furloughs for patrol officers for six months, then one furlough day in each of the following 12 months. crime ridden environment the last thing that the city needed was a 50% reduction in its police force. See Camden NJ Police Union Votes to Reject Offer to Save 100 Police Officer Jobs

In addition the city cut one-third of its firefighters and 100 other municipal employees, including building code inspectors. See Bankruptcy Should be on City’s Table

-          Severe Financial Problems – Only 12% of Camden’s budget of $163m comes from property taxes.  The city is broke and bankruptcy may be the best solution. See Bankruptcy Should be on City’s Table

-          Failed State and Federal Assistance – Governmental funds have been spent on large building projects: a new medical school, new law school and new state aquarium.  Inexplicably, monies have not been used to improve life in the city:

In 2002 the state approved a $175 million recovery package to save the city, but according to a yearlong investigation by the Philadelphia Inquirer, only 5 percent had been used to combat crime, improve schools, provide jobs or bolster municipal services.  See City of Ruins

The Municipal Crisis

Authors like Michael Shedlock and financial analysts like Meredith Whitney have been warning us of the crisis in municipal finance.   Camden is a dismal look into the future, and a scenario of what happens when civic corruption, misspent funds, public sector unions and a declining tax base collide.

There are other Camdens lurking in our country: Harrisburg, Detroit, Houston and others.  In the midst of a tepid economic recovery which threatens to revert to another (or some would say continuing) recession, police and firefighter layoffs imperil citizen safety. This is anything but a formula for reviving America’s cities.

As a final thought, we need to accept the reality that suburban enclaves are also at risk. If there is a collapse of government and law and order in Camden, how safe are the nearby more affluent Haddonfield, Moorestown and Cherry Hill bedroom communities?  It is doubtful that the growing chaos that is Camden will be contained within its city limits.

 

 

 

 

 

 

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22
Oct 10

Elements of an Unstable Financial System

We are currently caught up in the day to day gyrations of the stock, bond or foreign exchange markets.   Politicians tell us that we are recovering, but we just need more stimulus packages and investment tax credits.   The Federal Reserve proudly takes credit for “the recovery.”  They maintain we have avoided a depression, but at the same time report monthly that we need interest rates at zero indefinitely.  Members of the Federal Reserve and the financial press strongly hint that we need a second round of quantitative easing (the monetizing of debt), even though this program ended in March 2010.

This highly unstable financial system threatens to wreck the economy, deplete retirement savings and imperil democracy.  This is not hyperbole.  Let’s examine the indicia of instability:

  • A Failing Banking System – So far this year, 120 banks have failed.  This is well ahead of last year’s failure rate.  As of August, 829 of a total of 7800 FDIC supervised banks were on a watch list.  A watch list indicates a high probability of bank failure.  The prior year 416 banks were on this list.   See FDIC Finds 829 U.S. Banks at Risk
  • Foreclosure-Gate – Poor documentation during the foreclosure process, ranging from false affidavits to improper notarizations to suspected forgeries, looms as the next big scandal.    All this will lead to the real issue of violation or representations of representations and warranties during the securitization process.  It has already led to financial participants attempting to return mortgage backed securities to their originating banks. See Pimco, Blackrock and New York Fed  Seek Bank of America Mortgage Putbacks. Other money center banks face similar demands.  For just Bank of America, Goldman Sachs analysts predict the put back liability could be as much as $25b.  Foreclosure-gate and the “put back wars” will tie banks up in expensive litigation for years with the prospect of large losses.  See Goldman on Total BofA Putback Losses:$25 Billion Which Apparently is a Good Thing
  • High Frequency Trading – Lightening fast computer trading now dominates daily stock exchange activity.  Trades are based on small pricing differentials rather than stock fundamentals.  On May 7th, the Dow Jones Industrial Average plunged 700 points in 5 minutes.   The SEC investigation attributed the crash to high frequency trading.  See Speed-Addicted Traders Dominate Today’s Stock Market
  • QE2 and Government Manipulation of Asset Prices – Brian Sack of the New York Federal Reserve has openly stated that the goal of the Federal Reserve is to put a floor under asset prices.  Thus, the government is deliberately targeting and manipulating stock prices. Moreover QE2, which is the Federal Reserve openly buying government debt, has inflationary and even hyperinflationary potential. See Managing the Federal Reserve’s Balance Sheet
  • Exodus of Retail Investors – Government manipulation, high frequency trading, wild market gyrations and economic circumstances have driven the retail investor from the stock market.  The Investment Company Institute reports the 24th consecutive weekly retail outflow from equity mutual funds.  This year to date $81b has been withdrawn. See 24th Consecutive Outflow from Domestic Stock Mutual Funds is in the Books
  • Currency Wars – Despite denials from Secretary Geithner, the Administration and the Federal Reserve have engineered a 10% decline in the dollar since June 2010.  Import prices have skyrocketed for resources such as oil.    This has triggered currency wars between nations.  Foreign governments have responded with attempts to depreciate their own currencies and impose capital controls. See As Currency Declines, Currency Conflicts Arise
  • OTC Derivatives – Various forms of derivatives (credit default, interest rate and foreign exchange instruments) were one of the culprits for the 2008 financial crisis.  The Bank for International Settlements estimates that $600T of these instruments are currently outstanding.  One expert estimates that losses could run from $12.5T to $20.5T in the next crisis, with many institutions defaulting higher losses.
  • Zero Interest Rate Policy – This is a two-edged source of instability.  Banks can borrow at zero percent and use the funds to speculate, confident that the government will cover their losses.  Earning little in safe investments, prudent savers are encouraged to spend or speculate with their dwindling savings. See Why is Charles Schwab the Only One Concerned About Zero Interest Rates?
  • Leverage – The Basel III agreements were intended to impose more stringent capital requirements.  The agreement permits banks to leverage their deposits 20 times.  In the past 12 times leverage was considered prudent. Said another way, a mere 5 percent decline in an investment position under Basel III would result in the entire position being negative. See Basel III Summary, and the Fed’s Endorsement of 20x+ Leverage
  • Sovereign Default – Ireland is only the latest victim of an unstable international financial system. Initially forced to adopt austerity measures, the government recently had to bail out an Anglo-Irish bank that had just passed the EU stress test.  See An Angry Ireland Calls Out Europe.  The specter of sovereign default still remains in Europe and experts have questioned the soundness of US debt.
  • Looming Bailouts – Underfunded pension plans and state and local governments’ running huge budget deficits are the next potential candidates for massive federal bailouts. See, e.g., Is a $1 Trillion Bailout Ahead of State Pension Funds?

Strange Brew

Lack of government regulation, poorly thought out government interventions,   mercantilist government policies, greed, and a myriad of other factors have created a strange brew.  Every day we witness violent swings in the fixed income, stock market and foreign exchange markets.  These gyrations have consequences in the real world as markets soar and crash.  Savers are also consumers and their incomes have been destroyed.  Consumers are threatened with higher food and energy prices.  There is no safe place to invest funds.  The success of the domestic economy depends on the whim of one man, Ben Bernanke.  It is no surprise that investors are fleeing financial markets, and that gold soars.

We are running headlong into Stein’s Law (named for Herbert Stein, Nixon and Ford’s chief economic adviser): “if something cannot go on forever, it will stop.”  But when these gyrations stop, probably sooner rather than later, we will be headlong into the next great financial crisis.

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19
Aug 10

Artificial Sweeteners

Artificial sweeteners have been the subject of health concerns.  Aspartame, for example, has been found to be a migraine headache trigger.  Products containing it carry a health warning for PKU, a rare hereditary disease.  Today we learn that diet sodas markedly increase the risk of pre-term deliveries.  See Add Diet Soda to the List of Things to Avoid While Pregnant.

Similarly, the Federal Reserve and the Administration have not trusted that the economy can heal through natural market forces.  Instead we have been served up the economic equivalent of artificial sweeteners.  Concerned by slow growth, not even negative growth, the government again is firing up the machinery for money printing and stimulus.

In each instance, the government is intervening, distorting, and artificially “sweetening”  the bond market, the housing market and, indirectly, the stock market.  What are the consequences?

There is No Free Lunch

Martin Hutchinson in The Peril of False Bottoms targets faulty government policy as the reason for our anemic economic recovery.  Excessive economic stimulus and a misguided zero interest rate policy has created false bottoms in the housing and stock markets.    A false bottom is defined as a stabilized “price far above the likely long-run price equilibrium of the assets concerned.”

Bernanke has precedent for providing excessive liquidity and holding interest rates too low for too long.  Greenspan reacted to the internet stock market crash by flooding the market with liquidity.  Doing this drove the market to over 14,000 on the Dow Jones Index and created a housing boom.   In the 2008-2009 real estate and stock market crash we learned  how flawed this policy was.

More on False Bottoms

Hutchinson points out federally inspired housing market distortions:

House prices are currently 47% above their level in January 2000, according to the S&P Case-Shiller 20-city index, compared to a 49% rise in prices since that time – in other words, they are in real terms at the same level as at the top of an immense speculative boom.During the recent contortions, the U.S. monetary and fiscal authorities have established false bottoms in two markets. The first is housing, where subsidies to first-time buyers, ultra-low mortgage rates, government guarantees on $700,000 home mortgages and foreclosure-avoidance schemes have prevented the housing market from falling even to its average level where the average house price is about 3.4 times average earnings. The Peril of False Bottoms

These misguided policies have consequences:

…with additional buyers having been sucked into the market, it is now likely that house prices will fall further than this. Indeed, if the appalling suggestion put forward last week that the government through Fannie Mae and Freddie Mac forgive $1 trillion of defaulted home mortgages is put into effect, they will undoubtedly do so. Nothing could be more designed to destroy confidence in the housing market than a massive subsidy to the most foolish and improvident home buyers, at the expense of the thrifty and careful renters who are the major source of potential new demand for housing.

If the buyer pool is attacked in this way, or forced into unnecessary losses by being made to buy too soon, house prices may not bottom out at the market-clearing level … but may continue falling.  The Peril of False Bottoms

Wither the Stock Market?

The stock market is the second false bottom:

Currently at 10,650 as I write, the market is 35% above its appropriate “middling” target. The “trailing” P/E ratio of 20.4 on the Standard and Poors 500 is also above its historic average, even though corporate and bank earnings are currently inflated by ultra-low financing costs and a steep yield curve. Thus at some point we can expect reality to intrude, and the market to drop to its likely cycle low in the region of 5,000 on the Dow Jones index.

Again market prices are too high for any intelligent buyer.  And worse, buyers will then be unavailable to buy stocks at the bottom. The Perils of a False Bottom

Politics v. Economics

Politicians are worried about the next election.  Thus, we see the desperation of the Administration to throw economic caution to the wind.   Zero interest rates, forgiveness of imprudent debt, subsidies to overpaid public sector workers (with no corollary “give backs”) are all hallmarks of erratic and misguided government policy.  They also sacrifice long-term prudence for the feel good of short term stimulus.

Who will pay this price?  Unfortunately, it will be stock market investors, pension plans, life insurance companies and homeowners.  Directly or indirectly, that is virtually all of us.  We need to beware politicians handing out artificially sweetened candy. Just like aspartame and our physical health, artificial economic sweeteners can be harmful to our financial health.

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11
Aug 10

Awash in Legacy Costs

Legacy costs have strangled many American iconic and venerable American industrial firms.  The automobile and steel companies are recent victims of this growing scenario:  diminishing work force and profits supporting large and growing pension and retiree medical costs.  In many instances bankruptcy has been the corporation’s only way out.

The Financial Dictionary defines legacy costs in the private sector as follows:

Ongoing costs to a company that come from funding activities that, by definition, do not increase revenue. Perhaps the most prominent example of legacy costs is the funding of pension plans. Legacy costs often accrue when a company takes on too many responsibilities in times of strong performance or when it takes on an appropriate level of responsibility and then its priorities change.

Legacy costs also include retiree medical, life insurance and other promised benefits.

The recent turmoil in the financial markets has revealed a potentially larger legacy problem.  Not only is private industry suffering this stranglehold; legacy costs are also drowning state budgets in red ink. Like private business, the public sector is also saddled with pension, retiree medical and life insurance benefits.   Completing the analogy, many of these costs were taken on when state tax revenues (think profits) were high.  Politicians avoided confronting public employees and unions and chose the path of least resistance; that is, they capitulated to exorbitant demands.  Then they compounded the problem:  instead of direct layoffs, states resorted to early retirement pension sweeteners, which depleted pension assets.

The Current Status of Public Pension Plans and Other Benefits

On August 6th, the New York Times reported the massive underfunding of public pensions.  See Battle Looms over Huge Cost of Public Pensions. The Times discovered a February Pew Center for States study showing a $1 trillion pension underfunding. (We could have a whole different post as to why it took until August for the Times to report a study published in February.)   Worse yet, the Pew study may have been overly optimistic.  In other words, their methodology understated the liability and the deficit.  In contrast, the National Center for Policy Analysis’ Unfunded Liabilities of State and Government Employee Retirement Benefit Plans found that states were using too high a discount rate to determine employee liabilities.  Under the National Center for Policy Analysis deficits are far more alarming:

  • Unfunded liabilities for health and other benefits are
    $558 billion, compared to the reported $537 billion.
  • Thus, total unfunded liabilities for all benefit plans are an
    estimated $
  • Unfunded pension liabilities are approximately $2.5
    trillion, compared to the reported amount of $493 billion.
  • 3.1 trillion — nearly three times higher than
    the plans report. See Reality Beckons (Government Pensions)

While pensions are funded, other benefits like retiree medical, vision and dental have no assets side aside to fund them.  Moreover, based on current trends, medical costs are growing exponentially.

The New Battle Ground

Colorado undertook modest changes to its pension plans to lower future pension payments. The state legislature reduced its cost of living adjustment cap from 3.5% to 2%. The result was an immediate lawsuit from public employees:

Earlier this year, in an act of rare political courage, a bipartisan coalition of state legislators passed a pension overhaul bill. Among other things, the bill reduced the raise that people who are already retired get in their pension checks each year.

This sort of thing just isn’t done. States have asked current workers to contribute more, tweaked the formula for future hires or banned them from the pension plan altogether. But this was apparently the first time that state legislators had forced current retirees to share the pain.

Sharing the burden seems to be the obvious solution so we don’t continue to kick the problem into the future. See Battle Looms over Huge Cost of Public Pensions

Employees view their pensions as inviolable contracts, while the state is invoking changes as actuarial necessities.

Who Thinks About the Taxpayers?

Taxpayers are facing unemployment, the risk of losing their jobs and increasing costs of education, medical and energy.   Public employees are well paid, largely insulated against layoffs, and receive top of the line current and retiree benefit packages.  Barron’s points out that: “[m]ost public employees, if they hang around to retirement, can count on pensions equal to 75% to 90% of their pay in their highest-earning years.”  The $2 Trillion Hole.  Frequently, supervisors and employees collude to inflate final pay with shift and overtime pay in the last year of work.  Current and retiree medical benefits require minimum or no contribution.

In contrast, private sector benefit plans pale in generosity to public benefit plans.  I worked for a company for 32 years and my pension is a little more than 40% of my last five years of pay.  Retiree medical requires a 20% contribution.   Our plans had no cost of living adjustments.   My company’s plans were probably in the top 5% of benefit plans in America.   Most companies offer little more than a basic medical plan and no retiree benefits.

The federal government will soon run out of borrowing capacity.  In addition, there are questions of federalism; that is, the states are supposed to be responsible for their own finances.   Federal and state legislators and public unions  have to be far more realistic than they have been.  If they are not,  some of our largest states (think New York, New Jersey, California, Illinois) will suffer as did  GM and  Greece:  drowning in legacy costs.

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19
Jul 10

Reengineer First, Privatize Second

At the suggestion of one of my readers, I am going to try a slightly different format for this post.   I enjoy responding to Global Economic Trend Analysis, an excellent and well known blog written by Michael Shedlock (“Mish”).  Recently, I weighed in on his Transit Union Plays Nuclear Terrorist Card which analyzes the brazenness of public unions and the need to privatize government activities.  Here, in edited form, is my first comment:

One of Shedlock’s continuing themes is waste in government, especially at state and municipal levels.   His solution has been to privatize as much as possible.  Mish applauds Chris Christie, the recently elected NJ governor, for commissioning a study to evaluate privatizing state functions.  At the top of the list was privatization of motor vehicle inspectors.

I am a fan of privatization; however, there is a predicate step.  Before even the question, “should we privatize a function?” we should be asking, “do we really need to perform the function at all?”   Privatizing is a great idea after you have made a fundamental decision whether or not you need the service performed. The modern state is involved in too many questionable functions to begin with.

Here are two examples.  I have lived through many NJ motor vehicle inspections and I am still not sure of their purpose. The driver must stop the car to check the brakes, honk the horn and start the windshield wipers. An emissions test is also required. Why not just eliminate the entire process and every two years have an approved mechanic certify the car roadworthy or not.  Similarly, NJ may not have enough state parks, or some may argue there are too many.  Why not examine park usage and achieve savings by closing some of the parks before privatizing them?

In New York, candidate for governor Andrew Cuomo has promised to revisit the 1000 state agencies and commissions that have proliferated in the state. This is only a promise.  Let’s see if he follows through over the opposition of his union constituency.

Please consider:

http://www.prophetwithoutprofit.com/2009/09/29/why-not-reengineer-government/

http://www.prophetwithoutprofit.com/2010/03/10/can-we-afford-our-criminal-justice-system/

http://www.prophetwithoutprofit.com/2010/06/03/time-to-revisit-public-sector-reengineering/

My second comment, again edited:

One more thought on Governor Christie and reengineering the state government. The growth of state government is analogous to your garage or attic. Clutter grows because you put that old lawnmower, bike, chest of drawers, or dishes aside because someday you promise yourself that the item will be useful in the future. The clutter grows and you swear that you will spend a weekend or a day off taking the items to Goodwill or throwing them out. That day is usually postponed indefinitely.

State government grows the same way, with proliferations of new programs, agencies, and commissions.  In many cases, they are  supposed to be temporary. One day we realize that these temporary programs are now permanent and have a life of their own. No one wants to clean out “the government attic” because there is now a constituency that “needs” this governmental service. This constituency will produce impassioned pleas to newspaper editorial boards and take out ads. I would suggest that we are at the financial tipping point where the government “attic” needs to be cleaned out. It is a matter of both good will and financial necessity.

Conclusion

Reengineering government is now a financial necessity.  It would be a win for the taxpayer,  as not only would there be obvious savings, but also the possibility of better delivery of government services.  Before privatization, I would hire experts to decide what is a core governmental function, what functions can be effectively outsourced and privatized and what functions can be eliminated.  This requires “zero based” thinking and slaughtering of some sacred cows.  Do we have too many schools, state colleges, museums, state parks, transit lines?  Do we have too few?

Heresy perhaps, but somebody needs to ask the question rather than accept the status quo.

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14
Jul 10

Distortions

One theme we have explored in past posts is the negative role government has played in the economy.  See e.g., Let it Be and Can You Invest in the US Equity Markets? Government intervention in a capitalist economy distorts economic behavior.  Further, government anoints winners and losers without subjecting market participants to the rigors of a free marketplace.  See Government Intervention and Bowmar Brains.  Interventions occur on both state and federal levels.  Let’s examine some of the recently reported inevitable distortions.

Federal Employment

Andrew Briggs and Jason Wine examine the disparity between federal employee and private sector pay.  Federal employees with the same experience and education as private sector employees make 24% more.  Federal employees also receive generous health and pension benefits.   See The Government Pay Bonus.

In addition to compensation and benefit advantages, federal workers are shielded from layoffs and terminations.  Finally, I have extensive experience working with federal employees.  Do not expect that your phone call will be returned after 5 PM.

State Contractors

Illinois, like many other states, has out of control budget deficits and massive pension underfunding.  Michael Shedlock highlights the overweening sense of entitlement displayed by highway construction workers whose pay scale is determined by the state prevailing wage laws for public projects.  While making $50-$68 per hour, these workers are threatening to strike to increase their wages 5% per year to offset increased health care costs.  In contrast, hundreds of unemployed applicants have besieged Walmart to obtain $9.50 per hour positions in newly opened stores in the Chicago area.

Saving the Favored Banks

Amazingly, the top six banks’ holding companies made $51b in 2009 while the other 980 banks lost money:

Focus hard on this shocking Wall Street reality: The top six bank holding companies earned an aggregate of $51 billion in pretax income in 2009. We’re talking about JPMorgan Chase, Goldman Sachs, Bank of America, Morgan Stanley, Citigroup and Wells Fargo.

All of this pretax income can be attributed to their trading revenues of $59.7 billion. The proprietary trading operations of an oligopoly of banks, saved from disaster by Uncle Sam’s largesse and subsidized with cheap money from the central bank, was the single driving force behind the restoration of their fortunes and the renewed surge in their stock prices.

For those willing to go long when the outlook was the bleakest, they’ve banked a double in JPMorgan Chase, scored a quadruple in Citigroup and nearly a quintuple in BofA.

Some of the other 980 bank holding companies–like Bank of New York Mellon, PNC Financial Services, U.S. Bancorp and M&T Bank–lost an aggregate of $19 billion for the 2009 year. Bank of New York Mellon had the seventh-largest trading revenue–it was just 1.6% of the total. By comparison, Goldman Sachs had 36.2%, Bank of America 18.8%, JPMorgan Chase 15.4%, Morgan Stanley 11.3%, Citigroup 6.9% and Wells Fargo 4.2%. See Six Giant Banks Made $51 Billion Last Year; The Other 980 Lost Money

I suspect that much of the vaunted trading revenue came from Federal Reserve borrowing at 0-.25% interest rates, and then buying higher yielding treasury securities.  Would you call that investing or just “shooting fish in a barrel” courtesy of the US taxpayer?

Government Intervention and Economic Recovery

Distorting economic incentives is one factor retarding economic recovery.  Crony banks are guaranteed profits while eschewing Main Street lending.  Private sector employees face insecurity in the workplace;  that does not translate into robust discretionary spending.  Further, while not currently a problem, and with abundant surplus labor, private sector employers ultimately will compete with government compensation packages 24% higher than the private sector.

This is a smattering of the distorted economic incentives in the world of Obama, Geithner and Bernanke and their state counterparts.   Their constant meddling and direct interference in the private sector guarantees that we will have plenty of distortions  in the future.

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10
Jun 10

Bailout Nation Lives

Where is the coordination of economic policy among the Federal Reserve, the Treasury and Congress?  In testimony before Congress, Ben Bernanke, Chairman of the Federal Reserve warned against large budget deficits:

The Fed chief repeated his call for lawmakers to come up with a long-term plan to reduce the federal budget deficit, which is projected to widen to a record $1.55 trillion this fiscal year. “Unless we as a nation make a strong commitment to fiscal responsibility, in the longer run, we will have neither financial stability nor healthy economic growth,” he said.  See Bernanke Says Fed Prepared to Counter Effects of Europe Crisis

It is clear that bailouts are not consistent with fiscal responsibility.  But it seems the Administration and Congress are tone deaf to these no more bailout pleas.

No Constituency Left Behind

We have analyzed the bailout actions of the Bush and Obama administrations. See Are We a Socialist Country? It has been a long and undistinguished progression from Bear Stearns, AIG, American Express, GM, Chrysler, GE and others.  We have collectively decided that banks, insurance, automotive, industrial, credit card and other companies are too systemically important to fail, and are therefore bailout worthy.

Despite all protestation the Obama Administration appears to be on a constant search for new bailout candidates:

-          A $23B Bailout for Teachers – Education Secretary Arne Duncan urged Congress to support a $23b jobs bill to prevent teacher layoffs.

-          Why Leave Out Pension Funds? – Senator Casey, D-PA proposes affording two large multi-employer Teamster pension plans federal protection.  The estimated cost would be $8-10b.

-          US Largesse Goes Global – Through IMF membership, the US taxpayer will be funding the bailout of Greece and other European nations. IMF Chairman Boutros-Ghali pointed out the perilous financial position of the IMF and the need for more member capital contributions.  Rep. McMorris Rodgers, R-CA highlights the hidden cost to us:

“This should give pause to Treasury Secretary Geithner and others who boasted that the IMF’s bailout bonanza wouldn’t cost U.S. taxpayers a dime,” said Rep. McMorris Rodgers.  “In truth, the cost to U.S. taxpayers goes up every few weeks.  After the Greek bailout, it stood at about $7 billion; after the EU bailout, it stood at about $60 billion.  Now – based on Mr. Boutros-Ghali’s comments – we’re talking at possibly $100 billion or more.  This has got to stop.” See Congresswoman McMorris Rodgers Responds to IMF Statement Europe Bailout will Cost  US Taxpayers 100 billion+

-          As we have pointed out, Fannie Mae and Freddie Mac are uncapped, growing, perpetual bailouts. See Shredding the Social Fabric.

The Hidden Costs of Bailouts

Politicians are constantly on the prowl for a free lunch.  Bailouts and promises of “little cost to the taxpayer” provide that seemingly free repast.  A closer look at the bailout phenomenon shows us its high and hidden price tag.  A look at some unintended consequences:

  • Bailouts only add to the burgeoning federal deficit.
  • Ultimately, they will be paid for either through higher taxes, higher inflation or both.
  • We are eroding financial discipline.  GM was roundly criticized for giving away a new Corvette to a Detroit Tiger, who pitched a near perfect game.
  • Likewise, we are eroding fiscal discipline in states and municipalities, which should be cutting budgets and raising taxes rather than seeking bailouts.
  • We are compromising our most basic federal system of separation of powers, as a state and local function, education, becomes a federal ward.
  • We are encouraging moral hazard with reckless and profligate behavior (and prudent behavior is punished).
  • Bailouts beget other bailouts, as it become impossible to draw the line when future constituencies come to Washington for their bailout.
  • Today’s funding of bailouts limits the flexibility of the Administration to respond to future, more serious crises.

Fundamentally, bailouts are unfair, as one group is leveraging its political clout to earn a bailout at the expense of innocent taxpayers.  Rewarding the profligate and the irresponsible makes little sense as public policy.  It is time to end the bailouts.

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Municipal Finance / Political / State Finance — 0 Comments
3
Jun 10

Time to Revisit Public Sector Reengineering

Almost a year ago, I discussed the failure of government to analyze and remake itself.  See Why Not Reengineer Government? The private sector has embraced this core agenda and has emerged leaner, more profitable and productive.  For political reasons states and cities have been slower in this effort, despite the obvious need to do so.   Only with their budgets publicly in shambles are the savvy politicians slowly and reluctantly embracing reengineering.

State budget gaps have spawned two distinct approaches.   The first is the financial meat cleaver: slash budgets, furlough or lay off employees, and end grants to counties and municipalities.  But Andrew Cuomo, NY State Attorney General and candidate for governor proposes a more thoughtful approach.

How Many Agencies??

New York has more than 1000 byzantine state agencies designed like Rube Goldberg machines.  Let’s take a look at this phenomenon:

Robert A. Caro’s 1974 biography of Robert Moses, “The Power Broker,” chronicled the rise and expansion of the state’s largely autonomous system of public authorities, entities like the Niagara Falls Bridge Commission and the Metropolitan Transportation Authority. These bodies are responsible for the bulk of New York’s debt, and they control most of the state’s infrastructure.

But even state agencies, which are controlled by the governor’s office, have become Rube Goldberg-like bureaucracies. Mr. Cuomo’s report notes that the Health Department has had at least 87 administrative subgroups imposed upon it by legislation over the years, including 46 councils, 17 boards, 6 institutes, 6 committees, 5 facilities, 2 task forces, 2 offices, 2 advisory panels and a work group. One entity is called the Task Force on Health Effects of Toll Plaza Air Quality in New York City.  See Cuomo to Propose Eliminating Many State Agencies.

Now the state is functionally bankrupt.   Cuomo proposes a Spending and Government Efficiency Commission (another agency!) to overhaul and consolidate state government.  To eliminate and consolidate agencies, Cuomo would delegate broad powers from the legislature to the governor.  As a reference for how revolutionary this all is, Governor Al Smith effected the last such overhaul in 1919.

Furloughs and Cuts

California, Wisconsin, Maryland, Hawaii and other states have jumped on the other bandwagon, slashing budgets and furloughing employees. Not surprisingly, public sector unions are passionately resisting.  As indicated in my first post on this issue, California has 489 state agencies that cry out for consolidation or elimination.

Necessity is a Bad Mother

We have discussed the concept of “it doesn’t matter, until it matters.” No one cared about bloated public employee payrolls, rich compensation and benefits packages and proliferating governmental authorities, commissions and agencies.  We could afford it! Unfortunately, now we cannot.

I wish Andrew Cuomo well, but I have some gnawing concerns. Do we really need another commission to effect governmental restructuring?  Why not employ a politically independent consulting firm that is expert in reengineering?  What about privatizing governmental functions altogether?  Will a newly elected Governor Cuomo have the political resolve to convince a reluctant legislature?

If Cuomo merely intends to combine one thousand agencies into fewer ones without further examination of necessity, then he has missed a timely and historic opportunity.  We need a reassessment of what role we want government to play.  Zero based budgeting and a holistic and philosophical look at the role of government would be an excellent starting point.  Certainly, our political establishment has lost touch with the core role of government on its way to creating this unwieldy bureaucratic behemoth.

Necessity will be a bad mother and a frugal one too.

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American Society / Economics / Municipal Finance / Political — 0 Comments
15
Apr 10

Fraying at the Edges

We live in a technologically sophisticated society with advancements and improvements for all of us.  For the past three decades a torrent of easy money has financed creativity, research, manufacture, and sale of all these conveniences, luxuries, and civic and personal advancements.

The current financial crisis has not only turned off the cash spigot, but has exposed a glaring Achilles heel of all this progress.  Everything wears out.  Everything breaks once in a while.  And we need cash flow for maintenance.   Are we breaking down around the edges?

Anecdotes from the Front Lines of Consumer Central

Around the country and in my home town, I have noticed several disturbing trends:

  • Hotels – Staying in a “four star” resort on Hilton, Head Island, I noticed that the furniture and bedding was badly in need of replacement.  The televisions were still the old cathode ray tube variety instead of flat screen plasma.  Common area carpeting and furniture needed replacement.  Out of 20 or so exercise machines, five were out of order.   During the college spring break vacation period the hotel was half empty and we immediately got a free ocean front upgraded room.  Not an isolated instance, I have seen this pattern of poor maintenance in many other “high end” hotels.
  • Home Maintenance – My neighborhood is heavily wooded.  Many of the trees are infested with carpenter ants and viruses.  The major March nor’easter storm revealed that many of these trees should have been removed much earlier.  In fact, two people in a neighboring town were killed by a falling tree.  Because of budget cuts the town has been very slow to remove dead trees on public land, and so many town trees were damaged or destroyed, with consequences to businesses or homes.   The local utilities similarly responded slowly to any tree removal requests.

-          Anecdotally, other homeowners have delayed both minor and major repairs and renovation projects because of the economy.

  • Trash Removal – We are happy to bring our recyclables to the local Department of Public Works.  Our town has always had its recycling center open five days a week, but starting in 2010 the DPW will only accept recyclables on Thursday mornings and Fridays.
  • Road Maintenance – Both local and interstate roads are pockmarked with potholes.  Road crews seem to be scarce.  Last week I had the privilege of repairing a bent rim and replacing a $250 tire.  Of course, we have seen spectacular road maintenance failures, like the collapse of the I-35 bridge in Minneapolis.

Cash Flows and Maintenance

Everyone likes to build and create, few like to spend the money to maintain.  Despite monies being expended in the public sector, we are channeling little of it into repair and maintenance.   We live and work in technologically sophisticated homes and offices which require expensive and knowledgeable experts to maintain them.   With cash flow choked off by the recession and much of corporate America’s profits illusory rather than genuine, it is not clear where the maintenance money will come from.  America is rapidly downgrading itself from a first world country to something less.

Perhaps instead of billions to our banks to revive new home and commercial building, we should allocate billions to our maintenance budgets.

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