Transcript Local Governments on the Brink? Rick Mattoon Senior Economist and Economic Advisor Federal Reserve Bank of Chicago Economic Development in Rural Wisconsin October 26-27 Wausau, WI.

Local Governments on the
Brink?
Rick Mattoon
Senior Economist and Economic Advisor
Federal Reserve Bank of Chicago
Economic Development in Rural Wisconsin
October 26-27
Wausau, WI
Presentation outline
Issues and trends facing local
governments
 Issues in credit markets

This time was different


Context—the 2001 recession put state
governments under significant stress,
however the nature of the recession (the
tech bubble) had money being reallocated
from tech to real estate.
The ensuing increase in property values and
boom in new development helped property
tax oriented municipalities. Many
municipalities also create impact fees and
other development related taxes to further
capture the gains from the real estate boom.
This time was different
This recession has seen deep adjustments in property
values. The question is does this translate into
declining property tax collections?
 Why does this matter? Property tax is still the
largest source of local revenues and historically has
been a predictable and growing base. However since
the 1970s tax revolts, other revenue sources,
particularly fees have grown in importance. Also in
some states locals can have sales taxes and income
taxes. Lots of heterogeneity in local tax bases
 For farm areas…the opposite problem…rising farm
land values although might not translate into revenues
if special exemptions and treatment are common

Home Building And Prices
Single Family Housing Market
Home Price Indexes
(millions of units, annual rate)
(Q1-2000=100)
2.0
230
210
1.5
Case-Shiller Composite 20 Price Index
FHFA Purchase Only Price Index
Loan Performance Home Price Index
190
170
1.0
Permits
Starts
150
Jun-2011
Aug-2011
130
0.5
110
0.0
2000
'02
'04
'06
'08
2010
90
2000
'02
'04
'06
'08
2010
5
The adjustment process
It isn’t fast. Lots of communities use moving
averages or irregular assessment cycles for
calibrating taxable values. Leads to
confusion…the market value of my house is
X but the assessed value is Y.
 Some communities can simply adjust the tax
rate to adjust for the declining value
 If this isn’t possible, eventually revenues will
decline. For example, the National League of
Cities 2010 survey reported an expected
decline of 1.8% in property tax collections
after years of gains

National League of Cities 2011
How are they coping?






Personnel cuts
Delaying/canceling infrastructure
Cutting basic services
Drawing down reserves, not much on the
revenue side other than some fee increases
Biggest wildcard…state aid—in Wisconsin, 201113 budget cuts direct state aid by 7% ($48
million) and categorical aid by $136 million
Spending pressures include public safety and
infrastructure costs, employee related healthcare
costs, pensions
How are they coping…reserves are
significant and could act as a buffer
(ending balances as a percentage of expenditures, NLC)
What else might they do?
Never waste a crisis
 Michael Pagano, Dean UIC School of Public Administration

◦ Reform tax structure—link tax base to the underlying engines of
economic growth—particularly taxes on income and wages
◦ Broaden sales tax base to reflect consumers tastes for
consuming services
◦ Restructure property tax particularly to reflect growing number
of tax-exempt properties. Non-profits consume city services
◦ Consider regional tax authority—minimizes border wars and
some services might be better provided at a regional level
◦ Using pricing more effectively—fees should reflect cost of
services
What about muni-bond market and
debt issuance



2 schools of thought—Armageddon vs a
tempest in a teapot
Meredith Whitney—defaults will be in the
hundreds of billions. Even Nouriel Roubini
expects elevated (but not systemic)
problems with defaults of $100 billion over
the next five years
As a benchmark, S & P muni bond index
($1.27 trillion in debt) reported $2.65 billion
in defaults in 2010 and $2.9 billion in 2009.
The Tempest in the Teapot School

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Historic performance suggests defaults are rare (600
bankruptcy filings since the Great Depression) and
even when they occur bond holder recovery has
been above 80%, much better than private sector
Most of the defaults are in no-rated issues and tend
to be single-purpose governments—sewer systems,
housing projects, etc.
Lots of legal protections and state interventions to
prevent either a default or a Chapter 9 filing
Stigma of filing is high and this alone helps prevent
filings
Debt levels as a percentage of expenditures aren’t
that exaggerated and the term of debt issuance
seems matched to the life of the bonds.
Further evidence
Much of the poor performance of the muni market at the end of 2010 and
into 2011 is because of reasons other than a change in the underlying
credit-worthiness of issuers.
 Examples
◦ BABs (Build America Bonds) flooded the market at the end of the
year…might have overloaded the market for muni bonds even if these
are taxable
◦ Extension of Bush tax cuts—less need for wealthy to shelter income
◦ Rally in equity markets—repositioning portfolios
◦ Still able to issue…just at higher costs…Illinois Pension bonds ($3.7
billion in March) high rate (ranging from 4.96% for five year maturities
to 5.877% for bonds maturing in 2019). This was estimated at almost 2
full points above market for A1 issuers. This was also above the interest
rate offered on last years’ pension bond offering of $3.47 billion at
4.42% (five year maturities).
◦ End of mono-line insurers


Finally, the muni market rallied even after the S & P downgrade of
the U.S.
What might change this picture?

The dreaded off-balance sheet liabilities
◦ Pensions and OPEB
◦ Rating agencies might start treating this as a binding
obligation of the government so governments with large
unfunded liabilities might get taken to task
◦ Reported liabilities are probably understated (Novy-Marx
and Rauh). GASB rules allow for unrealistic discount rate
◦ Path to full funding is very difficult, according to N-M and
R, Wisconsin’s real liability is $56.2 billion which represents
3.7 years of state revenue. Milwaukee’s unfunded liability
($3.4 billion) works out to $14,853 per city household.
(Good news Chicago’s is $41,966)
◦ OPEB is even worse…pay as you go for the most part
Conclusion



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Municipal finances are under significant
stress, particularly for property tax reliant
towns.
Other forms of aid from state or feds seem
unlikely
Slow climb out for housing market will keep
the pressure on for a while
Special risks will be pension and OPEB
funding, federal tax reform such as capping
the deduction for home mortgages