Credit Freeze is Affecting Local Governments (Updated)

The New York Times reports on how the ripple effects of the credit freeze are beginning to trickle down to local economies.

Cities, states and other local governments have been effectively shut out of the bond markets for the last two weeks, raising the cost of day-to-day operations, threatening longer-term projects and dampening a broad source of jobs and stability at a time when other parts of the economy are weakening.

The sudden loss of credit, one of the ripple effects of the current financial turmoil, is affecting local governments in all parts of the country, rich and poor alike. In New York, a real estate boom has suddenly gone bust. Washington has shelved a planned bond offering to pay for terminal expansion and parking garages already under construction at Dulles and Reagan National Airports.

As Hilzoy points out, this is a bad time for this to be happening.

Heading into a recession is the worst time to cut back on projects like these, which provide people with good jobs, and can work to keep the economy going. The Federal Government can run a deficit, but most states cannot. So just at the time when people need these jobs the most, they end up having to cut back.

The Senate is voting on a bailout rescue proposal today, so we’ll see how that ends up affecting the interbank rates. I know I was skeptical about the initial Paulson proposal (which was terrible, let’s be honest), but the bills shaping up now are better, and directly address the problem facing us right now. (Megan McArdle, Dave Schuler and Kevin Drum get most of the credit in convincing me of the need for the Treasury to buy up the toxic mortgage assets, in case anyone’s keeping score at home.) Right now I expect that the Senate is going to pass its proposal. Whether the House will is something I’m still unsure of. Public opinion may be changing, but from what I hear the calls into Congress are still overwhelmingly opposed to any government purchase of these assets, so we’ll see.

(cross-posted to Heretical Ideas)

UPDATE (Dave Schuler)

I’ve been predicting that local governments would be likely to fall into financial difficulties when the housing bubble burst for a couple of years now and predicted that we’d start seeing local governments in distress due to credit problems right after Henry Paulson and Ben Bernanke’s announcement last week.

The collapse in the housing bubble strikes at two revenue streams that local governments are highly dependent on: sales tax revenue and automatic property tax revenue increases as a result of reassessment at higher value. I suspect that the first inclination will be to raise marginal rates. That’s what happened during the Depression of the 1930’s and it resulted in more foreclosures than would otherwise have occurred. It will exacerbate the problem.

I don’t know what things are like elsewhere but here in Chicago and Cook County where I live local officials have been extremely reluctant to cut city and county payrolls but that’s what needs to be done. That’s going to be particularly difficult as demand for government services will tend to rise during a recession.

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Alex Knapp
About Alex Knapp
Alex Knapp is Associate Editor at Forbes for science and games. He was a longtime blogger elsewhere before joining the OTB team in June 2005 and contributed some 700 posts through January 2013. Follow him on Twitter @TheAlexKnapp.

Comments

  1. JT says:

    This will have a major impact with crime, because spending money on police, the courts and even drug treatment will decrease due to lower tax income for the governments. As people lose their jobs, and as foreclosures increase, it’ll lead to multiple areas of government having a drop in their budgets.

  2. I’m not sure I understand Dave Schuler’s argument. Are you suggesting that local governments are “effectively shut out of the bond markets for the last two weeks” because of declines in sales and property tax revenues?

  3. Steve Plunk says:

    Slow down there fellas. I think your panic is premature.

    Why on earth would Washington start a construction project before issuing the bonds to pay for it? That’s almost impossible to do. I’d check that story.

    Publicly issued bonds are backed by governments so they are still very safe investments. The money fleeing the mortgage market is looking for someplace to go so I expect bond sales to be okay.

    Property taxes will not likely suffer much. Property is not reassessed on a regular basis and certainly not enough to have a material effect on current revenues. I’m not aware of any place that collects sales tax on real property. If I’m wrong please correct me.

    The relaxation of accounting rules yesterday should also free up credit as banks adjust their balance sheets.

  4. Wayne says:

    The problem with local governments is when times are good they increase spending when times are bad they increase spending. A small town where I went to high school has been declining in population for years and yet they want to spend even more money.

    From what I hear, people with good credit can still get loans. I guess some of these local governments are high risk. With some of their records of spending for years more than they brought in, I would have to agree.

  5. Dave Schuler says:

    No, I’ve made two different interrelated comments. The first, on the problems that local governments will see as sales tax revenues and property tax revenues slow, was only tangentially related to Alex’s point.

    The second, that I’ve been talking about credit problems on the part of local governments for the last week, is directly related to Alex’s point. Without delving more deeply into the matter I’d guess that local governments are seeing problems in the credit crunch for the same reason that lots of companies are: they’ve gotten into the habit of using short-term credit as a method of dealing with their cash flow issues. That’s an okay strategy during periods of low interest rates and easy availability but, well, that’s not right now. There’s also a credit-worthiness issue (which ties the two observations together) but I doubt that’s the primary problem.

  6. PD Shaw says:

    Locally, city services are being squeezed by gas prices; fire, public works and particularly police are about to run through their gas budget for the year.

  7. PD Shaw says:

    I meant to add that traditionally short-term borrowing would be how to deal with unanticipated shortfalls before the next budget.

  8. Michael says:

    Without delving more deeply into the matter I’d guess that local governments are seeing problems in the credit crunch for the same reason that lots of companies are: they’ve gotten into the habit of using short-term credit as a method of dealing with their cash flow issues. That’s an okay strategy during periods of low interest rates and easy availability but, well, that’s not right now.

    Here’s my question, are the banks having a liquidity crisis? Meaning, are they not lending out money because they don’t have enough to lend out, or are they not lending out money because they’re afraid of taking on even more bad assets? If it’s the latter, what would happen if we give them good assets? Specifically, what if the government takes a loan from the bank, at a higher interest rate then it’s credit worthiness would usually get, so that the banks have some known good loans on the books, and at a relatively high interest rate for their risk.

    The government can then funnel that money through the SBA, offer rates that are lower than what the banks are currently offering, but higher than what they have offered historically. Or the Fed can open up lending to non-banks, again at a higher rate than banks have loaned at historically so that we don’t compete with them once they get back on their game.

    Once things get better, the government can try and sell the loans to the banks, which should be appealing to them because they would have a higher interest rate than they would be offering at that time.

    Now I’m no economist, this was just a little outside-the-box thinging, it may be the worst idea ever (though it will be hard to beat the no-strings-attached $700 billion payout idea).

  9. Dave Schuler says:

    Locally, city services are being squeezed by gas prices; fire, public works and particularly police are about to run through their gas budget for the year.

    That’s true but something of a red herring when considered in the context of most local governments’ total budgets. Payroll costs usually dwarf gas costs.

    I mention that in the context of the Cook County budget. The Board has been complaining about the high cost of gasoline but not mentioning that the budget increases due to rising payrolls are an order of magnitude more than the budget increases due to rising fuel costs.

    This is a subject I’ve posted about pretty extensively. In Cook County’s case most of its budget problems are related to healthcare costs (including Cook County Hospital). Everything else is pretty controllable and sustainable but that’s rising completely out of proportion to revenue streams.

  10. RW Rogers says:

    Lincoln, California is a likely candidate for municipal disaster. Population in 2000 was about 11,000. Now it is 42,000+. Forbes called it America’s fastest growing city. Almost all of the increase is due to new single-family home construction and almost all of those “starter” homes. About 17% of those were officially classified as sub-prime. The same percentage of existing homeowners who refinanced were considered sub-prime. Hundreds if not a few thousand others were only marginally better off. Property values have plummeted. People are just walking away from their houses and renting elsewhere before a foreclosure shows up on their credit rating. Countrywide holds about 1 out of every 6 mortgages there and is reportedly so far behind in processing foreclosures that it takes about 8 months for them to begin. Many who have walked away have handed their keys to friends to live free until the foreclosure process is complete. One of my relatives who lives there says there are about a dozen squatters in their development of 250 houses. Lincoln took on a lot of bonded indebtedness to build out and is now faced with huge shortfalls in current income as a result of nonpayment of property taxes as well as lighting and landscape district fees, and the failure by developers to continue building new projects as anticipated.

  11. PD Shaw says:

    That’s true but something of a red herring when considered in the context of most local governments’ total budgets. Payroll costs usually dwarf gas costs.

    That’s true, but that just makes under-budgeting for gas more problematic. If you can’t borrow short-term to pay for unexpected expenses, you have to start firing people. And if they are union-protected that may not be immediate.

  12. mike says:

    Steve – property taxes are reassessed on a yearly basis in many places where there is no state income tax – my house in texas dropped in value by almost $20k last year (of course the value was inflated to begin with in my opinion) – if this happens across the board, which it has, it will effect budgets.