Municipal Budget Mess

A recent report from the National League of Cities projects a grim financial situation for many municipal governments during the next three years. According to the report the municipal sector "likely faces a combined, estimated shortfall of anywhere from $56 billion to $83 billion from 2010-2012." Such shortfalls will be "driven by declining tax revenues, ongoing service demands and cuts in state revenues". Facing large deficits, cities around the nation may be forced to "cure revenue declines and spending pressures with higher service fees, layoffs, unpaid furloughs, and drawing on reserves or canceling infrastructure projects".

The process of belt tightening has already begun in cities across the nation. In Michigan, the city of Jackson is asking municipal workers to take pay cuts to help close a $900,000 budget deficit. Toledo, Ohio, another rust belt city hard hit by the recession, may face a deficit of up to $44 million, and is being forced to consider "mid-contract union concessions, cutting city spending, and possibly asking the voters to increase the city's 2.25 percent income tax."

In California, already challenged by record state deficits, the city of Los Angeles may have a budget shortfall of $1 billion by 2013, "driven primarily by escalating employee pension costs and stagnant tax revenues". For the current fiscal year the city faces a deficit of $98 million. Under such budget conditions, the city's administrative officer projects substantial cuts to city services will be "unavoidable".

With states already facing their own set of budget challenges, the League of Cities is calling on the federal government to intercede. According to the League, "in the absence of additional federal intervention, a deepening local fiscal crisis could hobble the nation’s incipient recovery with more layoffs, furloughs, cancelled infrastructure projects, and reduced services." However, with an exploding federal debt load and federal budget deficits running at all time highs, municipal cries for increased aid may face a lukewarm reception in Washington, DC. Support for expanded stimulus efforts might prove lacking, with signs beginning to emerge that a mild economic recovery is underway, and many of the already passed stimulus dollars yet to be spent.

For now, cities facing deficits will have to find ways to solve the shortfall on their own. If they are unable to bridge the gap, municipalities may find themselves forced, like the city of Vallejo, California,to file for Chapter 9 bankruptcy protection.

A Milestone on the Road to Becoming a Third-World Economy

Northrop Grumman Corp started California’s New Year by announcing it is moving its headquarters to the Washington D.C. area. Unfortunately, they are neither the first nor the last major corporation to leave Southern California. It is a trend, one that may not last much longer, though since aren’t that many major corporations still headquartered in greater Los Angeles.

For decades, Southern California was the center of the aerospace world, a basic part of the Southern California’s DNA. Now, once Northrop leaves, there will be no major aerospace companies still headquartered in Southern California.

Aerospace is not the only industry abandoning Southern California. The region was once host to financial giants, like Bank of America, Security Pacific Bank, Countrywide, and First Interstate. Today, there are none. California was once a major automobile manufacturing state, with a dozen plants. Even the entertainment industry is slowly shifting away from its Hollywood roots.

When you lose corporate headquarters, you lose more than jobs. You lose the tax base, the leadership, the philanthropic giving, and the intangibles. Corporate headquarters are usually very good citizens.

Many local political leaders ignore this business’ exodus, or make excuses. The decline of the U.S. defense spending, aerospace spending in particular, is often given as a reason for the decline. But the last decade was not a bad one for defense; the industry thrived, just not in Southern California.

The reasons for this exodus are both simpler and less flattering than those usually given. One big reason is selfishness. California’s decline chose to consume, and not to produce. Wealthy, aging, Baby Boomers control the state. In the cause of “quality of life,” or “the environment,” they have succeeded in limiting opportunity for everyone else.

The other big reason for decline lies with governments, state and local, that now exist to serve themselves and not their citizens. The level of government goods and services, even infrastructure and basics, has declined, but state spending, adjusted for inflation and population, has continued to soar. The difference has been going into public employee’s pockets, through higher salaries, benefits, and generous retirement programs.

Remarkably, no Southern California economic sector is in ascendancy. Unemployment remains well above the national average, particularly in the middle class Inland Empire. The growth in bankruptcies has been about twice that of the United States. The state is becoming less equitable, the divide between those who have and those who do not have constantly growing, the middle class declining.

Southern California is starting to look a lot like a third-world economy, service based, inequitable, serving a wealthy, mostly aging few, with little opportunity for younger workers and a large underclass. Changing the region’s prospects will be very difficult. Nothing short of a major generational change in leadership is likely to change the current sad trajectory.

Avoiding Housing Bubbles: Regulating the (Land Use) Regulators

Federal Reserve Chairman Ben Bernacke called for stronger regulation to avoid future asset bubbles, such as the housing bubble that precipitated the international financial crisis (the Great Recession) in an Atlanta speech.

The Chairman appears to miss the fact that regulation itself was a principal cause of the Great Recession. The culprit, however, was not financial regulation, but rather land use regulation, which drove house prices so high in highly regulated markets. When households that could not afford their mortgages defaulted, the losses were far too intense for the mortgage industry to sustain, and thus the Great Recession.

This is not to ignore the role of Congress and others, which fueled more liberal mortgage credit, and created the excess and credit-unworthy
additional demand for home ownership.

This higher demand, however, was only a necessary, but not a sufficient condition for creating the bubble, which when burst, precipitated the worst economic crisis since the Great Depression. In many markets, there was relatively little increase in house prices relative to incomes, as prices remained at or below the historic Median Multiple (median house price divided by median household income) standard of 3.0. In other markets, however, prices reached from 5 to 11 times incomes.

Already, a new bubble may be on the way to developing. Even after the huge losses, house prices in California were only beginning to return to sustainable historic levels (3.0 Median Multiple). Since bottoming out, however, prices in California have risen 20%, at an annualized rate greater than that of any bubble year.

Perhaps the first principle of regulation is understanding what to regulate. In the case of the housing bubble, it was land use regulations themselves that needed to be regulated.
To avoid future housing bubbles, no more effective action could be taken than to repeal the restrictive land use regulations, without which the last bubble would have been, at most, only slight compared to the destructive reality that ensued.

More Money for Bailout CEOs

The day before leaving town to vacation in an opulent $9 million, 5-bedroom home in Hawaii, the Obama administration pledged unlimited financial support for Fannie Mae and Freddie Mac. The mortgage giants are already beneficiaries of $200 billion in taxpayer aid. On Christmas Eve, regulatory filings reported that the CEOs of the two firms are in line for $6 million in compensation. Merry Christmas!

Executive compensation is the subject of many academic studies, but one focused on Fannie Mae from two Harvard Law School professors is especially well-named: “Perverse Incentives, Nonperformance Pay and Camouflage”. Executives are able to take unlimited risks and reap unlimited upside rewards knowing that US taxpayers will foot the bill on the downside. The mortgage-backed securities issued by the two firms remain at the center of the causes-and-effects of the financial meltdown.

The compensation for Fannie Mae’s senior managers is recommended by the Compensation Committee “in consultation and with the approval of the Conservator”, which is the U.S. Federal Housing Finance Agency (FHFA). The FHFA was created in July 2008 when Bush signed the Housing and Economic Recovery Act. At the time, the Congressional Budget Office estimated that the $200 billion Act would save 400,000 homeowners – in the first six months, exactly one homeowner was able to refinance under the program. The Act also was supposed to clean up the subprime mortgage crisis – which it did not do as evidenced by the collapse of the global financial markets a few months later.

Back to the current problem of paying $6 million to run a bankrupt company whose every financial obligation is guaranteed by taxpayer money. Who is on the compensation committee that recommended this pay day? Dennis Beresford from Ernst & Young (E&Y); Brenda Gaines, recently from Citigroup; Jonathan Plutzik, from Credit Suisse First Boston; and David Sidwell, from Morgan Stanley.

Back in 2004, Ernst & Young was engaged as a consultant to Fannie Mae – right after the Securities and Exchange Commission banned E&Y from taking on new clients. Citigroup took $25 billion in TARP bailout money and Morgan Stanley took $10 billion. Credit Suisse benefited by a mere $400 million as their share of the AIG Financial Products group bailout. Needless to say, this Compensation Committee knows a thing or two about controversies and federal aid!

Enjoy your luxury Christmas vacation, Mr. President, while 45 out of 50 U.S. states are enjoying statistically significant decreases in employment in the face of rising prices. Please take some time to contemplate the words GE Chairman and CEO Jeff Immelt used in describing the leadership traits that need to change in America: “The richest people made the worst mistakes with the least accountability.”

And to the rest of you out there reading this, take some time to contemplate the words of Bill Moyers as he concluded a rather shocking essay of the role of lobbyists in the recent “healthcare reform” legislation: “Outrageous? You bet. But don't just get mad. Get busy.

World Small Area Map of GHG Emissions

The European Commission has just made a Google Earth overlay available showing annual greenhouse gas (GHG) emissions by 10 square kilometer quadrants. The overlay can be manipulated to show estimates from every year beginning in 1970. One of the most fascinating features is the GHG emissions on the oceans, from shipping lanes. All are green (fewer GHG tons), but one route stands out as by far the busiest, from Hong Kong and Japan through the Straits of Malacca and the Suez Canal to northern Europe.

The application is useful for broad reviews of GHG emissions by same-sized areas, though the zoom feature does not provide high resolution enough photography to discern differences at the smallest area level.

Bernanke: For Good or For Ill

This week, Time magazine named Federal Reserve Chairman Ben Bernanke “Person of the Year 2009.” CNBC’s panel of experts gave Bernanke the “Man of the Year” title (no misogynists there!) in 2008. And well they should since their sponsors are among the biggest recipients of the Paulson-Bernanke-Geithner bailout. As I select the link from their website to imbed in this story, an ad from Wells Fargo (NYSE: WFC) is displayed in the right half of the screen. Click on “home” and it’s an ad from General Motors (OTC: MTLQQ).

I imagine Bernanke is quite embarrassed this holiday season as a result of the many, many less than flattering comparisons he is receiving. CNBC’s sister network, MSNBC, took exception to anything flattering in the designation by reminding everyone that being named Person of the Year is not an honor. Time’s definition, according to MSNBC, is: “The person or persons who most affected the news and our lives, for good or for ill…” They list a few of the previous winners, including Adolf Hitler (1938), Joseph Stalin (1939), and Ayatollah Khomeini (1979). One writer likened Bernanke receiving the award to “celebrating an arsonist for his heroics in putting out a fire that he set.”

Regardless of Time managing editor Rick Stengel’s qualifying statements, the tone of the write-up suggests, to Charles Scaliger at The New American at least, that Bernanke has a “cult of personality” within the Washington, D.C. Beltway. If you’ve never met Bernanke, which I never have, it’s hard to imagine there is the kind of personality there that one could be cult-ish about. Former Federal Reserve Chairman Alan Greenspan, who I also never met, regardless of his other shortcomings had the ability to say what it took to get the economy to do what he wanted it to do – he didn’t always pick the best things to get it to do, but he was able to get a message across. Bernanke, on the other hand, never seems quite comfortable in front of Congress the way Greenspan used to appear. A nervous central banker is very bad for the economy.

The designation – whether or not it is an honor – came the day before the Senate Banking Committee approved President Obama’s nomination of Bernanke to four more years as Chairman of the Federal Reserve. That nomination and approval represent further steps in what Rolling Stone writer Matt Taibbi calls “Obama’s Big Sellout.” The President, and 16 out of 23 Senators on the Banking Committee, seem to hold the mistaken impression that those who got us into this mess are going to be able to get us out. Republican Senator Jim DeMint of South Carolina was among the dissenters: "We can't have a Federal Reserve that the majority of Americans no longer trust, and that's what we have today." Bernanke himself told Congress less than ten months ago that he didn’t know what to do about the economy. Maybe the eventual good that will come from Bernanke’s 2009 affect on our lives will be the demise of the Federal Reserve system in the United States and an end to the mountains of fiat money that it produced in vain efforts to solve the financial crisis that will forever be linked to Ben Bernanke’s name: Person of the Year “for good or for ill.”

Obama Credit for Bush Fuel Efficiency Improvement

The press’s love affair with President Obama goes so far as to give him credit for actions of his predecessor, George W. Bush. Over the last week, the New York Times and The Guardian,
Britain’s “quality leftist daily gave the President credit for working out a deal with auto makers to improve fuel efficiency by 30%.

Not quite. The Obama Administration worked out a deal with the automakers under which they would not sue if the already approved 2020 fuel efficiency standards were advanced to 2016. In fact, the 30% improvement, which was in the 2020 standards, was passed by Congress in 2007 and signed by President Bush.

This is not to deny credit to President Obama for working out the agreement with the auto industry that removed the possibility of legal challenges to advancing the Bush 30% improvement by 4 years. The government’s substantial financial stake in General Motors and Chrysler probably helped seal the deal.

“Planning Pool:” Length of Year Increases 800% in 2008 from Previous Year?

The Canadian planning blog “Planning Pool” congratulated the Charlotte, North Carolina light rail line, noting that it “experienced an 800% increase in ridership last year” (“Transit Success in Sprawl City,” December 4).

The impressive increase was made possible by comparing apples and oranges. Last year (2008) the Charlotte light rail service operated all year, while in the previous year (2007), service operated fewer than 40 days (the line opened in late November). Following its logic, the “Planning Pool” missed an even bigger story: apparently 2008 was 800% longer than the previous year (an increase from fewer than 40 days to 365).

Of course, it’s either apples or oranges and, one way or the other, a revision is in order.

The Case for Walking Away

First American CoreLogic, a real estate research company, recently released data on negative equity mortgages for the third quarter of 2009. The situation is stark. Nearly one in four U.S. mortgages (23%) is currently underwater, with the borrower owing more than the property is currently worth. According to First American, when mortgages "near" negative equity are tallied, the total number of mortgages near or currently underwater is around 14 million- "nearly 28 percent of all residential properties with a mortgage nationwide."

Being underwater does not necessarily mean that a borrower is at risk of default. Although foreclosures and payment delinquencies are currently at record levels nationwide in the wake of the popped real estate bubble, most borrowers facing negative equity continue to make their mortgage payments. While being underwater "is the best predictor for loan defaults," according to Sam Khater, economist with First American, "if you have your job and don’t encounter economic shock, you’ll most likely keep paying on your home."

But should you keep paying if you're underwater? Brent White, an Associate Professor of Law at the University of Arizona has examined the situation, and argues in a recent discussion paper that homeowners "should be walking away in droves." According to White, millions of homeowners "could save hundreds of thousands of dollars by strategically defaulting on their mortgages."

Such a strategic move comes with consequences for the borrower- most notably a negative impact on one's credit score. This has a quantifiable cost, but White states that "a few years of poor credit shouldn’t cost more than few thousand dollars," and notes that individuals can rebuild their credit rating over time, and can "plan in advance for a few years of limited credit."

Such costs are, argues White, "minimal compared to the financial benefit of strategic default." White makes use of the hypothetical example of a California couple purchasing an average priced ($585,000), averaged sized home in 2006 to demonstrate the case for default:

"Though they still owe about $560,000 on their home, it is now only worth $187,000. A similar house around the corner from Sam and Chris recently listed for $179,000, which, with a modest 5% down, would translate to a total monthly payment of less than $1200 per month – as compared to the $4300 that they currently pay. They could rent a similar house in the neighborhood for about $1000.

Assuming they intend to stay in their home ten years, Sam and Chris would save approximately $340,000 by walking away, including a monthly savings of at least $1700 on rent verses mortgage payments... If they stay in their home on the other hand, it will take Sam and Chris over 60 years just to recover their equity"

White argues that in such cases, borrowers are better off taking a short-term hit to their credit, and strategically defaulting to escape a long-term, crushing financial burden. By staying in the home, borrowers are taking money that could otherwise be saved for retirement or used for other purposes, and throwing it away to service a liability that is unlikely to show positive equity in their lifetime.

Such advice seems most likely to appeal to those upside-down in particularly hard-hit areas of the country, including California, Florida, Nevada and Arizona. However, as noted, most homeowners are sticking it out, and continuing to pay their mortgages. According to White, many who might otherwise make such a decision avoid doing so due to "fear, shame, and guilt," sentiments which are "actively cultivated" by the government and financial industry to keep homeowners from walking away.

It remains to be seen if underwater borrowers will overcome fear of the consequences and take White's advice to strategically default. Mortgage lenders most likely hope that his ideas remain firmly in the minority- as one mortgage executive stated in comments reacting to White's report, the argument for strategic default is "incredibly irresponsible and misinformed," and, if widely embraced, has the potential to "'tear apart the very basis' upon which mortgage lending rests". Losing otherwise performing mortgages to strategic default, whatever the economic sense for borrowers, could be yet another blow to an already reeling industry.

Goldman's Gunslingers: 401k + 9mm = 666?

In the new Wall Street math of the post-9/08 world, it seems that some people turn to humor and others to rage. First they burned down our 401k plans: some people found this funny and made jokes about their “201k” plans. The French got angry and took CEOs hostage. Now, Goldman bankers are buying semi-automatic weapons to protect themselves from the angry mob. Matt Taibbi is desperately seeking humor in this, currently rating it a 7 on a scale of 1 to 10. Alice Schroeder, the story’s originator, finds it humorless, suggesting there could (should?) be “proles…brandishing pitchforks at the doors of Park Avenue.”

In true on-the-ground reporting, a Bloomberg reporter wrote a story after a friend told her that he had written a character reference so that a Goldman Sachs banker could get a gun permit. Alice Schroeder (author of “The Snowball: Warren Buffett and the Business of Life”) also recounts a few examples of Goldman bankers using their other-worldly prescience to protect themselves: Goldman Sachs Chief Executive Office Lloyd Blankfein – only too well known now for saying that Goldman is doing “God’s work” – got a permit “to install a security gate at his house two months before Bear Stearns Cos. collapsed.”

All of this contributes to the view that Goldman Sachs is, indeed, “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.” I’m certain that Rolling Stone and Bloomberg have taken action to protect their right to be critical of Goldman. I’ve spent plenty of time on the phone with their fact checkers to know they put a lot of effort into being able to support every word they print. Blogger Mike Morgan, who founded, had to defend his right to be critical of Government Sachs by going to court last April when Goldman lawyers Chadbourne & Parke threatened him with trademark infringement.

But it isn’t just Goldman and it isn’t just our 401k retirement plans that have been damaged. There are fundamental problems in the way our capital markets are being run. The people running the system have known about these problems since at least the Crash of 1987 – I warned the U.S. central depository for all securities (Depository Trust Company) about it in 1993. Brooksley Born warned a presidential working group about it at a Treasury Department meeting in 1998 – and it contributed to the crash of 2008. As you read this today, nothing has been done to stop it from happening again. The real question is: which group will be the first to turn to action? Those with a sense of humor, those with a sense of security provided by a handgunor those with the sense to make changes?