Dallas was not exactly ground zero in the mid-2000s real estate boom and bust.  Outside of a few isolated neighborhoods, prices never rose very much.  And outside of a few new developments on the suburban fringe, oversupply was never much of a problem.   It was as if the city were splendidly isolated from the problems of the rest of the country.

So, when I went to visit my mother at her house in Dallas, I was a little surprised to see her trash bin overflowing.

“They only pick up the trash once per week now,” she told me, shaking her head.

The city of Dallas, in an attempt to rein in costs, has cut its garbage collection  services in half.  Of course, they have not cut the fees charged to homeowners by a single red cent.

This is not technically a tax hike.   But effectively, it is the same thing.  Homeowners are paying more for a given level of service.   And I expect this trend to be the norm at all levels of government.

We’ve written about this for years at HS Dent.  The “solution” for the government budget and debt crisis is some combination of lower services and higher taxes.  It’s as true for Social Security and Medicare as it is for Dallas trash collection.  We will all be paying more to all levels of government and getting less in return.

It doesn’t make for happy taxpayers and voters, of course.   But there is little alternative.  “Cutting spending” sounds like a better alternative than raising taxes or cutting service, but how do you cut spending on something like Social Security?  These are contractual obligations, and millions of seniors depend on it.

Don’t get me wrong, there is plenty of government waste that can be cut.  But one man’s government waste is another’s pet cause.

And it gets worse at the local level.  Everyone is “for” cutting government spending in the abstract.  But what if that means that your favorite local park has to be closed? Or that you have to store a week’s worth of rotting trash in the baking Texas sun?

I have no solution to this problem because there is no solution.   We could take to the streets and protest like the Greeks are doing over that country’s proposed austerity measures, but that would be no more effective than English King Canute’s attempt to command the tides.

Perhaps the only advice I can give is to prepare to fight hard for your piece of what promises to be a shrinking pie for the next several years.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The US Conference of Mayors is meeting in Washington and they are quickly realizing they have a common problem - no money.  As revenues from all sources decline, cities are not struggling to pay their bills because that would imply that they are close to even.  Instead, they are woefully short of paying their bills.  Looking at unemployment numbers that are stubbornly high, declining revenue, and ever increasing legacy costs, the Conference of Mayors has hit upon a solution - more stimulus. 

 The problem remains that this approach - stimulus spending - has not shown itself to function correctly, which would be successfully reigniting economic activity.  More money to spend that is borrowed from the general electorate is not the answer.  The answer is a lower level of spending that can be sustained by a smaller amount of tax receipts.  So far, no one wants to hear this, but eventually all cities and states will have to face the truth.  There is no going back to 2007.  Frankly, we shouldn’t want to.

Governor Patterson of New York has made no friends since taking over from embattled Spitzer.  Shortly after being sworn in to a standing ovation, Gov. Patterson told the legislature that the state was in real danger of going bankrupt.  As in NO MONEY IN THE BANK.  Since that time over a year ago, the governor has repeated his warning and called on the legislators to make the hard choices necessary to balance their budget.  But to no avail.  So here the state is, $7 billion in the hole for this year, and $14 billion under water for the 2011-2012 budget year.  The Rockefeller Institute outlines the situation here.

I bring this up because while we discuss the stock market, technology, banking, etc., in an effort to gauge any economic recovery, one of the best measures is continuing to flash warning signs.  Tax revenue receipts are, in a word, awful.  There is no faking them, no massaging the numbers.  When you look at the income to city, state, and even the federal government, it continues to be way off.  The main drivers of this income are property tax, income tax, and sales tax.   

Keep an eye out.  The remedy for this situation is always the same.  Lower benefits & higher taxes.  On both points the question is not if, but how much. 

Remember the “roving blackouts” that plagued California in the mid-2000s?  Well, we believe that is a good analogy for the state of the world capital markets circa 2009.  We’ll call it “The Roving Financial Crisis.”

Given that we all just lived through it, a full history lesson is not warranted.  But to review briefly, the crisis that began in the subprime mortgage market morphed into a broader housing crisis which in turn caused a meltdown in the capital markets and led to the failure or reorganization of virtually every Wall Street firm save Goldman Sachs (and even Goldman gladly accepted government bailout money as a precaution).

Well, it was rough, but we survived it.  The question now becomes “What happens next?”

According to Reuters, “The credit crisis that rocked U.S. residential mortgages and corporate credit markets may roil commercial real estate and sovereign debt markets next, senior investment managers said on Monday.” (see full article)

The “debt payment moratorium” (a.k.a. default) by Dubai World brought these risks to the forefront.  We commented on this recently in “Who’s Next.”  We wrote then that the growing consensus was that Greece was most likely to default, and today we see that the credit ratings agencies agree: “S&P Puts Greece, Portugal on Notice.”

Shockingly, given given the state of Greece’s finances (deficits this year are forecast to be an almost unbelievable 13% of GDP), Greek debt is yielding only  2% more than Germany.  To say the least, this would seem an insufficient risk premium…

So, the roving financial crisis continues.  Time will only tell where it pops up next.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Apparently state governments are fightin’ mad at the fact that foreclosures are wrecking their economies.  They are eyeing mortgage lenders for creating the debacle, and on top of that, those pesky banks and other lenders are not helping to remedy the situation, often taking much too long to deal with loan modifications and other initiatives aimed at slowing the rate of foreclosure.  In an effort to take control,  states are weighing the possibility of suing mortgage lenders for fraud.  Take a moment to ponder this.  State governments, who have wildly over-promised what they can support through their own funding, are contemplating suing mortgage lenders for fraud because they potentially lent money to people who couldn’t pay it back.  This falls into the “I can’t understand that” category.

If a lender makes a loan that can’t be paid back, isn’t that sort of a bad business practice?  To say that the lender did it for profit is a bit confounding, since the business model - lending to people who were marginal borrowers - seems like it is doomed from the beginning.  In fact, many of those lenders are out of business.

But let’s entertain the idea for a moment.  Someone out there is responsible for creating a boom in economic activity through the promise of cheap home ownership - or at least that is the working theory here.  That boom created an unsustainable flow of capital and economic activity within states that they became accustomed to having.  Now the spigot is turned off, so let’s blame the group that created this mania.  To do this, you have to keep asking for the next step.

It can’t be the mortgage lender.  Barring out and out fraud (which of course happened, and was always illegal), we are talking about the sweet talk of easy home ownership at a low price, getting in on the fastest game in town, the real estate bubble, and directed at those who were at best marginal buyers and at worst non-qualified buyers.  This of course came through the lenders, but it started a little further up the chain.  You have to look at the Fed with their insanely low interest rate policy, which kept prices low.  But that’s not the end of the line. 

For the end of the line, you have to look at the bucket of money that eventually purchased a big chunk of those mortgages backed by low income borrowers who are now in trouble.  That would be me and you, through our agents Fannie Mae and Freddie Mac.  In the 1990s we gave direction to those two government sponsored entersprises (GSEs) to make sure that a large percentage of the loans they purchased were those backed by low or modest income borrowers.  So in this line of thinking - that someone, somewhere, created all this mess in housing by making homes TOO affordable and persuading people to buy homes they couldn’t afford - would have to lead you back to the big buckets of money that kept buying the loans.

When are the states going to sue the federal government for fraud?  I don’t know, but if it does, it will be interesting to watch!

Don’t get me wrong, I do not think Congress is responsible for this mess.  I think this was a group effort - CDS’s which were gussied up insurance contracts with no capital behind them, rating agencies who pandered to issuers, the Federal Reserve, and Congress had a bit part.  There are many others, including borrowers themselves.  In this post I’m just addressing a current issue with states, I’m not agreeing with their analysis.

This is a follow-up to Rodney Johnson’s post today on state finances.  In the Wall Street Journal, we read today that “More Pain for State’s Taxpayers, Cities” is on the way.  The Journal writes,

The cost of shoring up Calpers, the troubled $200 billion pension fund for California public employees, will ultimately fall on the state’s 38 million residents, who are already dealing with tax increases and reduced public services.

The state and local governments are contractually bound to increase their payments to Calpers to help it make up for its investment losses of more than $50 billion in the fiscal year ended June 30.

California already had to spend $3.3 billion from its stretched general fund in the last fiscal year to make up for Calpers poor investment performance.  Cities and counties too have had to pour new monies into the fund at a time when they can scarcely afford to pay the electric bills in their offices.

There is no easy way out here…and green shoots or not, California’s problems are just beginning.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

The Rockefeller Institute, at www.rockinst.org, is dedicated to the study of public finance, usually at the state and local level.  They have operated not in obscurity, but certainly out of what you would think of as the limelight.  For the last year, things have been different.  They get a ton of attention, and rightfully so.  They are counting in real-time the cost of this meltdown as measured in the flow of revenues to city and state governments.  The numbers are sobering.  In the 2nd quarter of ‘09, income tax collection down 27.5%, sales tax down 9.5%.  This at a time when we are demanding more services of those exact entities through medicaid payments and other social outreach programs.

There can be no escaping either the cause or the effect.  We are nationally making do with less.  The US government has stepped in not only to fund but also to spend, hoping that it can bridge the gap until our private sector picks up enough to take over.  That won’t happen anytime soon. 

We’ve written extensively about the dire straits in which the state of California finds itself (click here).  But the Golden State is certainly not alone.  The states that saw the greatest excesses during the housing bubble are the same ones feeling the most pain today.  Consider Arizona:  The New York Times reports that “In Need of Cash, Arizona Puts Offices on Sale.”

The office building houses most of the State of Arizona’s government and was recently put on the market to help this broke state close its budget deficit.

It is looking like a pretty good deal, if the state can prove it is credit worthy…

To help close a $3.2 billion revenue shortfall, lawmakers allowed the sale and lease-back of the executive office tower, the buildings that house offices for both chambers of the State Legislature, as well as 10 prison complexes, a state mental hospital and other buildings. (For now, the historic Capitol, with its grand dome and aging interior, is not for sale, though state officials continue to ponder the possibility.)

Yes, the State of Arizona is actually considering selling its Capitol building!   What’s next, corporate naming rights?  How does the “Coca-Cola Capitol Building” sound?  Or the “Starbucks Statehouse”?  The possibilities are endless.

At any rate, the handwriting is on the wall here:  States can only close their budget gaps so many ways, and all involve some combination of higher taxes and lower levels of services for those dollars. This problem isn’t going away.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Apparently, in today’s economy consumers really do change their habits based on taxation.  Not only are Florida residents driving across the borders to avoid the $1/pack increase in cigarette taxes, but New Hampshire, which does not tax alcohol, is cashing in on increased sales from residents of neighboring states.

While this might seem to be a blinding glimpse of the obvious, I think there is more to it.  State legislators do not raise taxes in a vacuum, they have budget staff that analyze potential responses to tax increases in order to make intelligent estimates of revenue.  As I posted previously in Time To “Geek Up”… the State of FL has a Measures Affecting Revenue report that clearly shows an estimate of lost tax revenue from lower purchases, but then increased tax revenue from the higher tax.  The net number is of course positive, because if the estimate was negative it would not be worth doing.

My point about this being a more substantial issue is based on the fact that consumers are indeed reacting in apparently big numbers.  I believe this speaks to the state of the economy and the heightened sense of conservation among spenders, whereas two years ago I think convenience, by and large, would have won out. 

Time and again I’ve discussed this issue of those paying a tax reacting to an increase in the level of taxation.  As we ponder very big programs with very big price tags, it is worth considering what happens when we increase the price of a pack of cigarettes by a buck. 

We’ve collected some anecdotes over the past few days that reaffirm our view that, while things are slowly improving, we are far from being “out of the woods.”

For example, we find it telling that Nomura, the large Japanese investment bank, will enjoy a 6-year rent holiday in their new office space in London’s financial district.   According to the FT, the bank signed a 20-year lease and agreed to rent of 40 pounds sterling per square foot, considerably lower than the 70 pounds per square foot that was the going rate a few short years ago.  And the first 6 years of the lease are free!

With over capacity in the financial sector likely to persist for some time, it will be interesting to watch London’s two financial districts — Canary Wharf and the City — duke it out for a shrinking pool of corporate renters.   We don’t see this ending well for the owners of high-end London office space.

Meanwhile, with the global financial system still…shall we say, “impaired,” the old art of loan sharking has made an inglorious comeback (”Loan Sharks Circle Credit-Starved Consumers“).  The WSJ writes, “Loan sharks, so named because of their predatory behavior, are seeing a boost from the U.S. to Malaysia, where police launched a recent blitz against so-called au Lang gangs.”

Finally, no analysis of the weakness of the economy is complete without mentioning the deteriorating condition of state and local finances.  Despite an improvement in the overall economy, municipal woes “may be just beginning, since city finances tend to lag behind changing economic conditions by 18 months to several years.  Because of assessment cycles, for example, it often takes several years for city property taxes to reflect changes in property values. For this reason, cities will feel the deeper effects of the recession beyond 2009, with the worst years being 2010 and 2011.” (From “US city finances suffer as recession goes local“)

The FT reports that 9 out of 10 cities believe that their financial situation would be worse in 2010.

So, while some areas of the economy appear to be slowly improving, we repeat: we’re not out of the woods yet!

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy