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

Prohibition was repealed long ago, of course.   President Franklin Delano Roosevelt found it convenient to reintroduce booze into American popular culture for two reasons.  First, it won him votes.  Secondly, it brought in a windfall of tax revenues at a time when they were sorely needed.

With all levels of government — federal, state, and local — facing varying levels of fiscal crisis, and with faith in our elected representatives at a level so low as to border on outright contempt, might this move from FDR’s playbook be worth a look? Read the rest of this entry »

Rhode Island is following in California’s footsteps.  The tiny state is suffering economically, with unemployment reaching 12.7%, second only to Michigan.  To deal with their incredibly shrinking tax receipts, legislators have devised a plan that includes having just over 80% of the government workforce stay home a total of 12 days before the end of the fiscal year (June 30, 2010).  That’s amounts to just over a full paycheck for those that are paid twice a month.

The WSJ reported today that Michigan had offered to sell excess prison capacity to California to help that state deal with prison overcrowding.   The deal fell through, as California found cheaper “accommodations” elsewhere.  But this got me to thinking:  how exactly would selling prison services be classified in the state accounts?  Is it an “export”?  Tourism is considered an export business…might prisoners be accounted the same way? Read the rest of this entry »

Casino gambling, like booze and cigarettes, is one of those vices long believed to be recession proof, or at least strongly recession resistant.  When times are hard, the escapism of the casino — and the possibility of a big win that makes all your financial troubles disappear — becomes appealing.

So, we were surprised to see this reported in the WSJ:  ”States’ revenue from casinos, slot machines and lotteries is falling for the first tie in many of the 48 states that have grown to depend on gambling as a crucial source of income.”

We see some interesting trends in the data (see chart below).  The gambling “destination” states like Nevada (Las Vegas) and New Jersey (Atlantic City) have gotten hit hard, while casinos in states that cater to a more local clientele, like Oklahoma, Pennsylvania, etc.) are actually doing quite well. Read the rest of this entry »