Tag: Financial Crisis

Stop The Wall Street Bonuses

These are tough times for Michael Bloomberg’s free-spending “luxury city.” High-end condominium speculators – long considered impervious to the mortgage crisis – are shivering in the bitter cold this winter. Four billion dollars in building projects have been postponed or canceled outright, in large part because Wall Street’s bonus babies are getting a tad less than they are accustomed to.

Despite this, I would suspect most of America thinks Wall Street, and New York’s financial community, has not suffered enough. Industry bonuses are still expected to total well over $20 billion – small compared to last year’s stupendous $33.2 billion, but not an insignificant New Year’s present for the very people who have played a crucial role in wrecking the world economy.

By one calculation, this sum breaks down to $137,000 per banker. For middling executives with eight years on the job, bonuses could average $625,000, 15 times the average income for American households. Without the infusion of taxpayer cash, it seems certain that these numbers would have been significantly less. Feel better now, America?

True, some high-profile top executives wary of facing Congress have announced they will not be taking their stupendous bonuses this year. But these people should be able to scrape by with the tens of millions they bagged last year.

However, some of the biggest losers – such as bailout-owed insurer AIG – seem to lack even a basic sense of shame. It appears AIG is handing out bonuses ranging from $92,000 to $4 million to some 168 employees. It wouldn’t shock me if some of these fall into the pockets of the same folks whose actions have proven an unmitigated disaster for both shareholders and the country.

If only autoworkers, unemployed real estate agents and most of the rest of us, who are struggling to make our mortgage payments, had it so good. More important still, this state of affairs is not likely to encourage much faith in the capitalist system here or abroad. If free enterprise is worth anything, it should be about performance, risk and reward. By that standard, there is no justification for any bonuses on Wall Street this year.

“It’s hard to believe they are still getting bonuses after wrecking so many lives,” marvels Susanne Trimbath, a financial analyst at STP Advisors. “This no longer has anything to do with performance but has become an entitlement.”

Critically, Trimbath reminds us, we need to remember that some of these same bonus babies are primarily responsible for the housing meltdown that helped undermine the rest of the economy. It was Wall Street’s slicing and dicing of mortgage securities – not just McMansion-hunting suburbanites – that created the financial bases for the sub-prime loans and other excesses in the first place.

The whole bonus mania, Trimbath adds, contributed to the problem. It encouraged investment bankers to “push the [mortgage securities] crap out the door, because that’s how they could earn bigger bonuses.”

In the end, the remnants of Wall Street’s legions are still richly rewarded for their handiwork in unraveling the economy. This scenario turns Milton Friedman’s excellent point about the “social responsibility” of business on its head. Friedman correctly suggested that a businessperson’s primary obligation was not to serve some conjured-up idea of the public good but rather to make money for their shareholders and investors.

One wonders what the late Nobel laureate would say to the same Wall Streeters who are desperate to get props for being green or socially enlightened but have no shame about devastating their investors.

This spectacle could have long-term consequences for Wall Street’s future as an icon of capitalism. Someone in Congress (presumably not from New York) is sure to call for hearings once people learn of the big bonuses being doled out at bailed-out firms like Goldman Sachs. The class bent to enrich themselves with public largesse, it turns out, includes more than sleazy Chicago politicians.

A populist rube from the Atlanta exurbs or the Great Plains might even come up with the bright idea to stamp out new bonuses and expropriate some of the ill-gotten gains made in previous years.

The biggest push back will likely come from Robert Rubin disciples like Timothy Geithner, who will soon take over the Treasury, and the new National Economic Council chief, Larry Summers. Rubin will surely see the logic of Wall Street’s compensation system, since apparently he made over $115 million at Citigroup (where he serves on the board) while the firm has lost more than 70% of its value.

Along with Bloomberg and Sen. Charles Schumer – aided, perhaps, by the star power of their proposed puppet Caroline Kennedy – these worthies will fight off any attack against the bonus babies. No doubt they will argue such action would harm New York’s economy. Think of what smaller or no bonuses will mean to the dog-walkers, toenail painters, personal trainers and high-end travel and real estate agents of Manhattan.

ProPublica’s frequently updated map of financial bailout recipients reflects a massive transfer of money from the rest of the country to New York. A few other places – Chicago, Minneapolis, San Francisco – also have licked clean the seemingly bottomless federal ice cream bowl. What about the rest of the country?

Even New Yorkers should consider whether bailing out Wall Streeters is so great for them in the end. Once among the most recession-proof economies in the country, the Big Apple’s dependence on financial bonuses has made it increasingly subject to the market’s boom and bust cycles.

Indeed, the perverse effects of the bonus economy may well do more harm to New York than its political leaders let on or even realize. For one thing, it doesn’t create many new high-end jobs; even before the meltdown, industry employment from the last “boom” never reached peak levels hit in 2000.

What these bonuses foster, instead, is an ultra-expensive environment inhospitable to more middle-class employment, although it does create a boom market for low-end service workers. The cost of living in Manhattan is the nation’s highest, standing at twice the national average.

Once a city of capitalist aspiration, New York’s economy has devolved into a plutonomy where, in 2007, financial services employees gained a remarkable one-third of all income, much of it in the form of bonuses.

Meanwhile, the city’s middle-class ranks shrink. The Big Apple now has the smallest percentage of middle-class residents – barely half – of any major urban center. Perhaps even worse, the flow of bonus checks has persuaded successive city governments that it’s not necessary to diversify the economy or cut exorbitant costs.

Maybe it is time to end the whole way Wall Street operates – for the good of America, New York and indeed the reputation of capitalism. An insane system that overly rewards a few for being in the right place at the right time has outlived its usefulness. A more reasonable way of rewarding performance – and punishing missteps – needs to be put in its place.

I hope the financial industry takes the lead in making these reforms. If not, change will come anyway – likely in the ham-fisted way that comes naturally to Washington.

This article originally appeared at Forbes.

Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

January 6, 2009
How Detroit Lost the Millennials, and Maybe the Rest of Us, Too

The current debate over whether to save our domestic auto industry has revealed some starkly different views about the future of manufacturing in America among economists, elected officials, and corporate executives. There are many disagreements about solutions to the Big Three’s current financial difficulties, but the more fundamental debate lies in whether the industry should be bent to the will of the government’s environmental priorities or if it should serve only the needs of the companies’ customers and their shareholders.

But there’s something more at stake: the long-term credibility of Detroit among the rising generation of Millennials. These young people, after all, are the future consumers for the auto industry and winning them – or at least a significant portion of them – over is critical to the industry’s long-term prospects in the marketplace and in the halls of Congress.

The enormous investments the federal government has been making in private enterprises, including the auto industry, will test the ability of private sector executives to meet the expectations of this very civically minded generation. Sadly, so far, it’s a test many business leaders seem likely to fail.

In the case of the American auto industry, this failure has deep roots. Over the past few decades the leaders of the Big Three repeatedly have failed to move their industry in new directions, even when the opportunity to do so has plainly been put before them.

Attempts to nudge Detroit into producing more fuel-efficient vehicles have been going on since the 1973-4 Arab Oil embargo, which led Congress to establish Corporate Average Fuel Efficiency (CAFÉ) standards for cars and light trucks. The target was for cars to meet an average of 27.5 miles per gallon (mpg) by 1985. On Earth Day, 1992, Bill Clinton proposed to raise that standard even further to 45 mpg after he was elected President.

When Al Gore was asked to join the ticket, auto industry executives, terrified at the prospect that the man who had called for the abolition of the internal combustion engine might become Vice President, implored the leadership of the United Automobile Workers (UAW) to meet with the candidates and bring them to their senses. The lobbying effort worked. Under pressure from Owen Beiber, then UAW president, and Steve Yokich, who was his designated successor, and the powerful Democratic Congressman from Dearborn, Michigan, John Dingell, Clinton agreed to delay the adoption of higher CAFÉ standards until it could be proven that such goals were attainable.

This formulation opened the door for what came to be known as the Partnership for a New Generation of Vehicles or PNGV. Reluctantly supported by the Big Three, PNGV provided approximately a quarter of a billion dollars in government research funds to demonstrate the feasibility of producing a midsize sedan that could get 80 mpg. Often called “the moon shot of the 90s,” each car company was to make a prototype of such a vehicle by the politically convenient year of 2000 and begin mass production by 2004, another presidential election year.

After a few years of technological research, reviewed by the independent National Research Council (NRC), the partnership settled on the combination of a hybrid gasoline and electric powered propulsion system as the most promising approach. But by 1997, the car companies were resisting development of even a prototype for such a vehicle.

Vice President Gore, who had been in charge of the PNGV program since its inception, decided to meet with the Big Three CEOs to make sure they did not forget their past commitments. The answer from Detroit was emphatic: profits were coming from SUVs and heavy-duty trucks, not cars. Gore suggested they deploy a 60 mpg hybrid passenger sedan in 2002 rather than waiting for an 80 mpg version in 2004. Ford’s Peter Pestillo and his UAW ally, Steve Yokich, quickly replied, “no way.” Pestillo maintained, “we need much more time than that to make them cost competitive.” Gore could have, but didn’t, embarrass his host by pointing out that Toyota’s Prius was already delivering 55 mpg.

Not all executives were blind to the challenge. General Motors’ Vice-Chairman, Harry Pearce had been the driving force behind GM’s ill-fated EV1 electric car experiment. Despite a bout with leukemia that took him out of consideration for CEO of the company, he and his allies within GM exerted powerful influence on the company’s CEO, Jack Smith. He also won over an influential ally at Ford, the Chairman of its Board of Directors, William Clay “Bill” Ford, Jr., great grandson of the company’s founder.

At the Detroit Auto Show in January, 1999 Bill Ford personally introduced a new line of electric cars, under the brand name, THINK. Even though Honda and GM had abandoned the concept of an all electric vehicle by then, Ford said he thought there was still a niche market for such a car. Tellingly, Jac Nasser, Ford’s newly installed CEO, demonstrated his attitude toward these ideas by treating the visiting Secretary of Transportation, Rodney Slater, to a personal trip in a new Jaguar Roadster with the highest horsepower and worst gasoline mileage of any car at the show.

Right after that display of internal differences at Ford, Harry Pearce personally presided over the public introduction of General Motors’ PNGV hybrid prototype car, which delivered 80 mpg fuel efficiency, while seating a family of five comfortably. He then surprised everyone by revealing GM’s real vision of the future – a hydrogen fuel cell powered car called the “Precept” that got 108 mpg in its initial EPA tests. He grandly predicted that such cars would be on the road by 2010.

Clearly the industry was at a critical fork in the road. At a 2000 meeting at the Detroit airport, almost exactly one year to the day since their last meeting, Vice President Gore suggested to auto company executives that developing these products could enhance both the industry’s image and each company’s individual brands. Gore reminded his listeners, “It’s not just the substance of the issue you need to consider. You also need to think about the symbolism of the decision. Putting SUVs into the PNGV project would change the public’s perception of where you are going in the future.”

Jac Nasser wanted to know if such a commitment would change the dialogue between the industry and government. Gore suggested he would put his personal reputation behind such an agreement, which would garner the auto industry a great deal of positive press and appeal to the growing ranks of environmentally minded consumers.

But when it came time to put their reputation on the line, the auto executives blinked. The CEOs were not ready to commit to any specific production goals. This less-than-clarion call for a green automotive industry future made it only to page B4 of the Wall Street Journal the next day and was otherwise ignored by the rest of the public that the participants were hoping to impress.

Today, only Ford, the one American auto company not to ask for a bailout in 2008, is ready to offer a car that meets the original Clinton target. In showrooms in 2009, its Fusion Hybrid five-passenger sedan uses the hybrid technologies first explored in the PNGV to get 45 mpg in city driving, more on the highway, and costs about $30,000. As a result, Ford is in a much better position today to weather the whirlwind of change in consumer tastes and financial markets, even without the support of the federal government.

Unfortunately for America, General Motors, the largest of the Big Three, went in almost the opposite direction. Rick Wagoner, who became General Motors’ CEO in June 2000, chose to pursue an SUV-centered strategy that won big profits for a brief period. Since then, however, GM stock has plunged 95%, from $60 per share to roughly $3 in late 2008. General Motors, which lost $70 billion since 2005, has seen its market share cut in half. Having failed to embrace a public partnership with a sympathetic government, Wagoner was forced to beg for a federal bailout with onerous conditions. Seven years after the fateful auto summit with Al Gore, when asked what decision he most regretted, Wagoner told Motor Trend magazine, “ending the EV1 electric car program and not putting the right resources into PNGV. It didn’t affect profitability but it did affect image.” [emphasis added]

Had the auto industry taken Gore’s lead a decade ago and built a positive image among the very environmentally conscious Millennial Generation, it might have built a constituency to support the government’s bailout. Instead, the companies’ brands, particularly GM’s, have taken such a beating that the President-elect recently reminded the car companies that “the American people’s patience is wearing thin.” In contrast to young Baby Boomers buying songs by the Beach Boys celebrating the Motor City’s products, the country seems ready to drive their “Chevy to the levee” and tell the company “the levee is dry.”

But that is not the right answer. Millennials bring not only an acute environmental consciousness to the country’s political debate, but a desire for pragmatic solutions to the nation’s problems that promote economic equality and opportunity. To secure Millenials’ support, however, the domestic automobile industry needs to be seen as a contributor in ending America’s dependence on foreign oil and improving our environment. Not only would such an approach assure the industry’s future profitability, it would also remake its image in a way that will appeal to both their future customers and the politicians they support.

Morley Winograd, co-author with Michael D. Hais of Millennial Makeover: MySpace, YouTube, and the Future of American Politics (Rutgers University Press: 2008), served as Senior Policy Advisor to Vice President Gore where he witnessed the events described in this article. He and Mike Hais are also fellows of NDN and the New Policy Institute.

January 5, 2009
Current Policy Overlooks the New Homeless

San Francisco: A Chevron employee is forced to move his family of four into their Mitsubishi Gallant after being laid off…

Atlanta: Jeniece Richards moved from Michigan to Atlanta a year ago, but despite her best efforts, and two college degrees, remains homeless. She is living in temporary housing with her two children and younger brother…

Denver: As Carrie Hinkle’s hours dwindled, she was forced to choose between paying rent or buying food for her daughter. The two are now working with local agencies towards permanent housing, again…

These stories, plucked from the headlines of the past months are more than the typical holiday coverage. They show faces of the newly homeless, growing as the economy crumbles and opportunities fade.

Facing layoffs and deep cuts in working hours, many in fragile circumstances could no longer afford their mortgage. More commonly, they were renting from a landlord who foreclosed on their residence. Healthy, hardworking and addiction-free, the new homeless are closer in demeanor and behavior to our neighbors than the overly-typified street drunk.

Homeless resource programs across the country have been reporting record requests for assistance. A recent report from the U.S. Conference of Mayors found that, of 21 cities surveyed, 20 reported an increase in requests for food, with 59 percent coming from families. Nationwide, increased food stamps claims – a clear indicator of rising poverty – reached a record 31.6 million in September, up more than four million in a year according to the New York Times.

California, which has had a homeless problem for decades, has become the epicenter for the newly homeless. The state’s unemployment rate rose to 8.4 percent in November from 5.4 percent in 2007, making it the third highest in the nation. Compounding the homeless problem is the state’s high foreclosure rates (third in the country, according to RealtyTrac data). Homeless programs from San Francisco to San Diego are reporting record numbers, mostly from newly homeless residents impacted by the housing crises or falling economy.

Sadly this surge in homelessness comes just after a period when the problem was finally getting under control. One study by the Interagency Council on Homelessness found a 12 percent decrease in overall homelessness when comparing 2005 to 2007 data. That same time period also reveals a staggering 30 percent decrease in chronic homelessness (defined as being homeless for either over a year or for multiple stints).

In 2000, the National Alliance to End Homelessness crafted their landmark Ten Year Plan to End Homelessness. With successful bipartisan funding, 355 Ten Year Plans have been put into action nationwide.

Such plans, and a strong economy, accelerated the recent gains in the fight against homelessness. But the surge in newly homeless and shrinking budgets now threatens to reverse the progress.

New York City’s municipal shelter systems have seen record-setting increases over the past three months, according to the City’s Department of Homeless Services, but deep cuts loom ahead. Already, the city’s current budget includes a 3 million dollar decrease in outreach funding.

Denver plans to slash nearly a fourth of its funding for homeless initiatives at a time when the city reports a 38-percent increase in homelessness over the past year (Denver Post).

This situation will get much worse. A 20 percent increase of urban homelessness has been projected by the Interagency Council on Homelessness for 2009. Escalating homelessness and looming funding cuts create conditions for a renewed homeless crisis.

In the past debate has focused on the mentally ill and substance abusers, but the new homeless represent different phenomena. President-elect Obama has the responsibility to increase assistance to the degree that reflects the expanding problem. Washington seems all too willing to prop up the corporate players of the American economy, but let us not forget about the hardest hit by these times. Swift action must be taken to assure that the problem of the new homeless becomes no more than a historical footnote – to assure that we as Americans can look back with pride knowing that even during our hardest hour, all were cared for.

Ilie Mitaru is the founder and director of WebRoots Campaigns, based in Portland, OR, the company offers web and New Media strategy solutions to non-profits, political campaigns and market-driven clients.

January 5, 2009
Stimulate Manufacturing and Production, Not Consumption and Consumerism

As store earnings plunged last week, the National Retail Federation proposed that the country create the mother of all sales by suspending taxes on all purchases. These tax holidays would occur in March, July and October and be national in scope.

The bill, they suggested, should be picked up by – who else? – the federal taxpayer, who would make up for the lost local revenues even for the five states without sales taxes. The rationale, suggests the Federation’s chairman, J.C. Penney Chief Executive Myron Ullman III, in a letter to President-elect Barack Obama, would be “to help stimulate consumer spending as one of the first priorities of your new administration.”

Now I can understand the manager at the local Target, Macy’s or Nordstrom feeling a bit neglected as money pours out to prop up financial institutions and the Big Three. This proposed subsidy for mallrats, however, makes the previous somewhat-dubious bailouts look like good policy.

In fact, if there is one thing Americans do not need, it is yet another incentive to spend money they do not have. This has become a fixture of stimulus-think under the Bernanke-Bush regime. Remember the tax rebates earlier in the year? That was a big help, wasn’t it?

Sadly, this “shop ’til you go bankrupt” strategy is being adopted by the new kingpins in Washington as well. Already you can hear Barney Frank, chair of the House Financial Services Committee, talking about a big stimulus to “prop up consumption.”

This quick-fix approach has become a new genus of bipartisan madness. Like “the best minds of my generation … looking for an angry fix” – to recall Allen Ginsberg’s Howl – politicians and policymakers seem to feel we need some quick high to restore our battered economy.

Like a bad drug habit, reckless stimulation may make us feel better in the short term, but it could leave us shaky later on. To be effective over time, a stimulus plan must first address some fundamental challenges that have haunted the American economy for a generation.

Of course, there are countries that should be spending more. Places like China, Germany and Japan have gotten fat off our consumption. Now their beggar-thy-neighbor policies are backfiring as shopaholic nations, most notably the U.S., rein in their spending.

In contrast, our economy’s failing stems from not producing nearly enough in goods and services to pay our bills. Our long-term weakness stems not from a shortage of consumer credit – the main obsession of Wall Street and both parties – but from the decline in manufacturing, growing dependence on imported fuel and deteriorating basic infrastructure.

Our consumption patterns – coupled with disdain for production – explain how our deficit in goods-related trade alone has soared over the past two decades from roughly $100 billion annually to over $800 billion. In the process, we have created an enormous shift in currency reserves to countries like China, Russia, India, Korea, Brazil and Taiwan. They produce and save too much; we consume and borrow too much.

Reversing this dangerous disequilibrium does not necessitate the end for American-style capitalism – as suggested recently by France’s president, Nicolas Sarkozy – but instead a paradigm shift within it.

First, we need to swear off our addiction to hype-driven bubbles, seen first in technology and more recently in real estate. The fact that the government may be about to start yet another – this one colored “green” – suggests bad habits are hard to break.

Of course, bubbles certainly benefit some individuals and companies, most notably the financial sectors, who can best take advantage of wild speculative swings. The financial sector’s share of profits more than doubled as a percentage of national income since the 1980s.

However, this pattern has not worked so well for most Americans, who have seen their wages stagnate or even fall. Most of us would benefit far more from robust growth that stems from productive industries like energy, fiber, food, logistics and manufacturing. Parts of the industrial Midwest, Texas and the Southeast have enjoyed expansions in these fields – until the onset of the recession, at least.

More important, productive economic growth creates demography far more egalitarian than the Namibia-like bifurcation that characterizes bubble centers like Manhattan and San Francisco. In fact, notes University of Washington demographer Richard Morrill, areas with greater concentration of these kinds of industries tend to suffer less inequality and offer better prospects for the average middle class worker.

Concerns over income equality should persuade Democrats – the supposed party of the people – to focus primarily on the basics of economic growth. This is precisely what we have not been doing for over a generation.

Just think of the billions sunk into convention centers, yuppie condos, performing arts centers and other ephemera. These produce some high-wage short-term construction and architecture jobs, but after that, they offer largely low-paying service work. Meanwhile the Chinese and other competitors dredge new harbors, build high-speed rail systems, new freeways and fiber-optic lines – the keys for pushing their economies to the next stage.

Sure, you can say the Chinese are also hurting from this financial crisis. But at least they can pay for their own stimulus. The Germans, Russians and Japanese, for now, can also dip into their dollar reserves to pay for new infrastructure investment. In contrast, we will have to beg the money for our stimulus like some busted-up small-town bookie.

More serious yet, the real problem may be whether we even want to make the changes necessary to boost our economy. Americans were once masters of both innovation and production, but we have begun to fall behind on both counts.

Indeed, our policies no longer focus on such things as manufacturing and energy production, deeming them beneath our dignity. As early as the mid-1980s, the New York Stock Exchange issued a report baldly stating that “a strong manufacturing economy is not a requisite for a prosperous economy.”

At the same time, we have deluded ourselves into believing that a small number of “creative” alchemists – software engineers, hedge fund managers, urban developers – could transform code, cash and condos into limitless pots of gold. The huge winnings of these few would then allow the rest of us to spend like teenagers on a borrowed credit card, consuming everything made by the hard-working fools abroad.

By now we should know better. Americans possess no monopoly on “creativity.” Our suppliers abroad are using the billions made from selling us everyday stuff to help finance future moves up the value-added scale. You can see it in every critical field from aerospace, steel and pharmaceuticals to software services, fashion design and entertainment.

Americans can meet this challenge but not by goading the family to spend more at Wal-Mart. Instead, we need to remember what actually drives economic growth. The ultimate fate of the economy will not be determined in the malls, but in the mines, oilfields, farms, factories, design shops and laboratories of a more productive economy.

This article originally appeared at Forbes.

Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

December 30, 2008

A Housing Boom, but for Whom?

By Susanne Trimbath and Juan Montoya

We just passed an era when the “American Dream” of home ownership was diminished as the growth of home prices outpaced income. From 2001 through 2006, home prices grew at an annual average of 6.85%, more than three times the growth rate for income.

This divergence between income and housing costs has turned out to be a disaster, particularly for buyers at the lower end of the spectrum. In contrast, affluent buyers – those making over $120,000 – the bubble may still have been a boom, even if not quite as large as many had hoped for.

For middle and working class people, the pressure on affordability was offset by historically low mortgage interest rates which fell from over 11 percent around the time of the 1987 Stock Market Crash to 6 percent in 2002. Yet if stable interest rates were beneficial to overall affordability, the artificially low interest rates promoted by the Federal Reserve may have created instability. By allowing people to increase their purchasing power to an extraordinary level, low mortgage interest rates fueled a rapid escalation in housing prices.

Now that prices are falling quicker than incomes, there should be a surge in new buyers. Since 1975, whenever the ratio of mortgage payments to income falls, home sales usually rise. The correlation coefficient indicates that for every 1% improvement in affordability there is a 2% increase in home sales. But now, something is wrong. In 2007, for every 1% improvement in affordability, home sales fell by 2%.

Part of the problem is that prices still are simply too high. Even as recently as August 2008, the median home price was still historically high in comparison to median income – about 4 times. It takes lower rates than in the past for a family with the median income to afford the median priced house. This means that homes are less affordable today than they were 6 years ago.

The last time that home sales fell as they became more affordable was in the 1990s at a time known as a “credit crunch.” At that time, the ratio of home prices to income was actually lower – 3.8 times in September 1990 compared to 4.3 in September 2008. The difference was that between 1990 and 1992 mortgage interest rates averaged a hefty 9.26%. In the last 3 years, the average was 6.14% and while the words “credit crisis” bled in headlines around the world, the regular mortgage interest rate barely budged.

What we are clearly witnessing is a fundamental slow-down in the gains towards homeownership. Of course, most of the gains in homeownership in the US were made in the 20 years after World War II: owner-occupied housing went from 43% in 1940 to 62% in 1960. In the 40 years that followed ownership crept up a bit, from 62% to 68%.

Boom, yes. But for Whom?

One disturbing aspect of this slow-down has been its effects by class. Overall, ownership has gained only among households making $120,000 or more; for all other groups the ratio of owners to renters is lower today than it was in 1999. (About 80% of American households have income less than $100,000 per year. For Hispanics and African Americans, the number is closer to 90%.)

There have been some exceptions, particularly among minorities targeted by national policy: expanding home ownership opportunities for minorities was a fundamental aim of President Bush’s housing policy. In the early years of this decade Hispanics enjoyed a net 2.6 percentage point gain in home ownership. In the next four years, while most Americans were seeing a decrease in home ownership, the Hispanic population continued to see gains. Although African Americans initially gained more than Whites in home ownership, they gave back more of those gains in the housing collapse

The great irony is that exactly those programs aimed at improving affordability may have been responsible for this recent decline. We first wrote about Housing Affordability in 2002. One of our concerns then proved to be true: buyers would focus on “can I afford this home” instead of “what is this home worth.” Although there were some gains in overall home ownership rates in the US during the early part of the boom, about 40 percent of that was given back during the last four years as home prices surged out of reach.

	Rate	Change in Rate
Location	2008 Q2	1999-2004	2004-2008	1999 – 2008
US	68.1	2.2	-0.9	1.3
Northeast	65.3	1.9	0.3	2.2
Midwest	71.7	2.1	-2.1	0.0
South	70.2	1.8	-0.7	1.1
West	63.0	3.3	-1.2	2.1
City	53.4	2.7	0.3	3.0
Suburb	75.5	2.1	-0.2	1.9
Non-metro*	74.9	0.9	-1.4	-0.5
White	75.2	2.8	-0.8	2.0
Black	48.4	3.0	-1.3	1.7
Other**	60.2	5.5	0.6	6.1
Multi	56.4	NA	-4.0	NA
Hispanic	49.6	2.6	1.5	4.1

Table based on historical data from US Housing Market Conditions, U.S. Department of Housing and Urban Development, Office of Policy Development and Research,
*Non-metro includes all areas outside metropolitan statistical areas (non-urban). Note from Census.gov: For Census 2000, the Census Bureau classifies as “urban” all territory, population, and housing units located within an urbanized area (UA) or an urban cluster (UC). It delineates UA and UC boundaries to encompass densely settled territory, which consists of: core census block groups or blocks that have a population density of at least 1,000 people per square mile and surrounding census blocks that have an overall density of at least 500 people per square mile.
**”Other” includes “Asian”, which reports household incomes about 20% to 30% higher than the Racial/Ethnic category “All” regardless of income level category.

The areas with the biggest losses in home ownership rates in the 2004-2008 period were outside the cities, particularly in the Midwest which encompasses Missouri, Iowa, Kansas, Nebraska, Minnesota and the Dakotas (west north central) plus Wisconsin, Illinois, Indiana, Michigan and Ohio (east north central). Of the geographic segments, non-metropolitan Americans gained the least in home ownership in the 1999-2004 housing boom; and only the Midwest geographic segment gave back more.

What about the future? The Obama-Biden Agenda Plan on Urban Policy mentions housing nine times, including a headline on “Housing” with plans for making the mortgage interest tax deduction available to all homeowners (it currently requires itemization) and an increase in the supply of affordable housing throughout Metropolitan Regions. The former should help middle-class households; the latter will help lower-income households. This is not a continuation of the Bush Administration policy which relied on stimulating the demand for housing by providing mechanisms to bring households into the market. The data shows that low income households barely kept even on ownership (versus renting) under this policy, middle-class households suffered tremendous losses and only the wealthy, those making more than $120,000 in income, had a gain in home ownership.

The last President ignored our advice in 2002: “A more balanced effort to stimulate supply would equilibrate the potential adverse affect on prices” from over stimulating demand. Let’s hope this new President gets the balance right.

Dr. Trimbath is a former manager of depository trust and clearing corporations in San Francisco and New York. She is co-author of Beyond Junk Bonds: Expanding High Yield Markets (Oxford University Press, 2003), a review of the post-Drexel world of non-investment grade bond markets. Dr. Trimbath is also co-editor of and a contributor to The Savings and Loan Crisis: Lessons from a Regulatory Failure (Kluwer Academic Press, 2004)

Mr. Montoya obtained his MBA from Babson College (Wellesley, MA) and is a former research analyst at the Milken Institute (Santa Monica, CA) where he coauthored Housing Affordability in Three Dimensions with Dr. Trimbath. He currently works in the foodservice industry.

December 28, 2008

Phantom Bonds Update: The New Treasury Bond Owner’s Manual

Shortly after my piece on Phantom Bonds, Blame Wall Street’s Phantom Bonds For The Credit Crisis, posted here on NewGeography.com in November, a friend called from New York to ask if I’d seen the latest news. Bloomberg News reported on December 10 that “…The three-year note auction drew a yield of 1.245 percent, the lowest on record… The three-month bill rate [fell] to minus 0.01 percent yesterday.” The US Treasury is seeing interest rates on its notes that are “the lowest since it started auctioning them in 1929.”

My friend is an intelligent person, a lawyer who managed to accumulate more than $1 million working a 9-to-5 job in a not-for-profit firm and retire in her 50s. Some of her portfolio is in Treasury bonds, so she had a lot of questions. In the course of our conversation, it became clear that I wasn’t going to be able to explain all she needed to know on the phone, despite her background. I decided to write this short owner’s manual.

Here’s how it works, and how it ties back to the problem of phantom bonds. When the US government needs to raise money it authorizes its agent, the Federal Reserve Bank (FRB), to sell securities. The different names for these securities are associated with how long they will remain outstanding, like the term of a loan: bills are up to 1 year, notes are up to 7 years, and anything longer than that is a bond. We’ll just call them bonds to make it easy.

The FRB has relationships with several primary dealers like Citigroup, Goldman Sachs, JP Morgan, and Morgan Stanley. When notifications are sent out that some bonds will be sold, these primary dealers submit bids in the form of prices. If a financial institution bids $99 for a $100 bond, then that bond will essentially pay – or ‘yield’— roughly 1% from the US Treasury (UST) to its holder. If the investor bids $101 for the $100 bond, then it will pay 1% for the privilege of lending money to the UST; the bond’s ‘yield’ would then be minus 1%. That’s a very good thing if you happen to be the UST, which of course we all are because it’s all taxpayer money.

So— as the prices of bonds rise, the yields fall, and these yields translate into the interest rate that the UST pays to the bondholders in order to borrow the money it needs to fund the budget deficit (and to refinance the existing national debt).

This is all roughly speaking, of course. But the idea is that the interest rates are set based on the prices that are bid in something that’s like a blind auction. The bidders don’t see the other bids, but because there are more bids than there are bonds available, financial institutions will bid the highest prices they can to avoid being shut out altogether. (FRB usually gets bids for 2 to 3 times as many bonds as they have available to sell.) This is good for UST, with a heavy emphasis on the “us”! High bond prices translate into low interest rate loans for UST.

Bonds are funny that way: when a bond’s price goes up, its interest rate goes down, and interest is the cost of borrowing money. So we should like to see Treasury bonds selling at very high prices, and with very low costs to the UST. Unfortunately, all those fails-to-deliver — those phantom bonds — especially over the past few months, had the effect of pushing down the price of bonds by (artificially) increasing the supply. That was keeping the interest rate paid by UST higher than it needed to be over the last year or so.

When bond prices are high — or inching up, as they are now — we all benefit. UST sold $32 billion in 30-day Treasury bills on December 9th at a yield of 0%, meaning that investors are lending UST money for nothing except the promise to return their money without losing any of it. Investors bid for four times as many of these particular Treasury bills as were available for sale. This is as it should be.

As the primary brokers rush to cover their phantoms — those failed to deliver Treasuries of the past — in order to settle their transactions, we’re seeing a surge in the price of treasury securities. The prices of bonds are rising, the yield is falling; the UST is paying lower rates on the money it borrows from investors.

An increase in the price of the new bonds can also mean that the price of existing bonds – those already outstanding – will also increase. The increase in the prices of outstanding bonds will help my friend in New York. A good part of her $1 million retirement portfolio is invested in Treasuries. Treasury bond funds, like Merrill Lynch and Vanguard, are earning 11 to 12 percent for their investors.

These high rates of return in Treasury bond funds won’t last forever, of course. The number of fails-to-deliver in Treasuries is falling quickly, now that the spotlight is on. When settlement is final and on time, then the usual rules of supply and demand will apply. Prices of new bonds and those bonds in the funds (the outstanding bonds) will even out. But the demand for UST bonds will likely stay strong as long as there is global financial turmoil. And that demand turns out to be good for the US (lower interest rates) and good for us (higher prices for the bonds in funds).

People like my friend in New York ask me if Treasury bonds are safe. I tell them: if the US Treasury fails to pay you back, you’ll have bigger problems than a decrease in the value of your portfolio.

Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Her training in finance and economics began with editing briefing documents for the Economic Research Department of the Federal Reserve Bank of San Francisco. She worked in operations at depository trust and clearing corporations in San Francisco and New York, including Depository Trust Company, a subsidiary of DTCC; formerly, she was a Senior Research Economist studying capital markets at the Milken Institute. Her PhD in economics is from New York University. In addition to teaching economics and finance at New York University and University of Southern California (Marshall School of Business), Trimbath is co-author of Beyond Junk Bonds: Expanding High Yield Markets.

December 24, 2008
Will the Bubble Burst Aspen?

Aspen is a great town. Its uniqueness extends beyond its spectacular geography to its amenities, people and community spirit. It’s a world-class, year-round Rocky Mountain resort offering great food, music, skiing, shopping – great everything – right in the middle of a real, functioning, small American community.

It’s no surprise people like it, want to keep it going. And not just the good, smart people who live in Aspen full-time and those who own second homes there (including some of the wealthiest people on Earth), but the thousands of good, smart people who visit every year to address big issues at the Aspen Institute and numerous other forums. These include elites of American arts, sciences, politics and economics with amazing amounts of brainpower and money at their disposal.

But geographic realities plus inexorable economic, demographic, and social trends are conspiring against the best of intentions. The future of Aspen – playground to the smart, rich and famous – may soon become untenable.

The financial crisis dominates thinking now. Could it be the catalyst that signals the beginning of the end of business as usual: the start of a major, long-term and permanent change?

The list of interested parties includes a wide cross section of year-round residents, second homeowners, business and property owners, public officials, visitors, employers and employees, builders and construction companies, managers and personnel at SkiCo (the town’s largest employer).

I have both personal and professional interests in trends in Aspen, and have been fortunate to visit many times and spend considerable time there over the past 35 years. My in-laws have been gracious and generous hosts (how lucky is that?), and in my role as an analyst of economic and demographic trends, I have been invited to speak, make presentations and attend seminars on many occasions (I always accept!).

Over the years I have personally seen the transformation from funky (I think the first time I skied there was in jeans and a sweatshirt) to glam and chic. To me it has always posed the classic development problem: how do you both improve and preserve what you’ve got, without setting forces in motion that undermine what you were trying to protect?

Before the housing and economic meltdown Aspen’s future was considered in State of the Aspen Area 2008, a report commissioned by the Aspen City Council and Pitkin County Board of Commissioners to provide guidance for future decisions on issues ranging from housing to growth management to transportation. The goal was to generate a 10-year community vision for the future, but that future may have to be put on hold.

The report highlighted several trends that seemed to pose serious challenges for Aspen. Most prominently, it suggested that the Aspen economy was becoming dangerously dependent on real estate and construction, as opposed to the original drivers of skiing, lodging and retail/restaurants. There were many new jobs, but a decrease in available housing for workers.

Aspen backs up to the Continental divide (closed all winter)! The Roaring Fork Valley is steep and narrow. Low- and middle-income workers must all live and commute “down valley.” But down-valley communities, where one used to be able to find cheap housing, have themselves become too crowded and expensive.

On top of this the Roaring Fork Valley has moved within sight of being “built out.” Traffic congestion is expanding up and down the valley (there is only one road – Route 82 – to get in or out of town), reaching intolerable levels during rush hours which start earlier and end later. A population of primary and second homeowners increasingly “aging in place” (with large percentages intending to retire in place), taking both their labor and residences off the market, exacerbate existing housing/lodging/worker imbalances.

The only reason the town “works” now is massive cross-subsidization. The fabulously wealthy subsidize the town budget with high property taxes on their mansions (even though some are in residence only a few weeks a year). They also subsidize the many arts, cultural attractions and charities so ubiquitous to Aspen as well as a range of services for year-round residents, from child care to education, health services, senior services, and police and fire departments.

Revenues from the rich and ultra-rich also pay for a town government that has a budget of $100 million plus for a town of 6000 permanent residents. In other words, Aspen could not afford itself if it had to rely on itself. Yet it was assumed the system would continue to work indefinitely because of the belief that “there will always be [a need for] an Aspen,” a playground for the ultra wealthy who spent freely and gave generously.

The burst of the housing bubble, and now the financial and economic crisis, throw that assumption into doubt. Even before the financial meltdown, the usual source of funds – more building to generate more fees, and/or raising taxes on visitors and residents (those both full-time and part-time) – were reaching limits. Now many construction projects have come to a virtual halt; it is no longer certain there will be buyers or a market for the completed structures – developers need to stop bleeding cash immediately. The value of building permits issued in Aspen this year is down 47 percent through Dec. 10.

Meanwhile the all-important non-profit sector has fallen into a tailspin. Contributions to the arts and other charities are primed to plummet. Endowment funds have lost millions. Sales tax revenue, which is the main tax source, will soon crash due to decreased tourism. Visitor reservations are dramatically down this Holiday season; retail stores are posting “Help Not Wanted” signs.

As a result, Aspen, a city unused to troubles, now has about all it can handle. Budget cuts threaten to cause havoc. Cuts in services, both governmental and those subsidized directly by the wealthy patrons, seem inevitable. Conflicts among elected officials, business, full- and part-time citizens could get ugly.

Of course, there is always the possibility that Aspen will weather the storm: after one or two down seasons at most, the number of visitors and dollars collected, spent and donated will resume their inexorable rise. After all, the ultra rich, trendy and connected will always need a playground. The problems listed above are not impervious to solutions; those bridges will be crossed when encountered by lots of brainpower and money.

In addition, not everyone is alarmed by the economic crisis and housing crash; some Aspen residents are indeed rooting for it, welcoming a lull in the constant construction, development and traffic, and hoping a slowdown will ameliorate such problems as the housing and worker shortages. Fiscal constraints will also bring some sanity back to (what they feel has been) the town government’s extravagance.

Long, slow decline is certainly possible: less spending, fewer visits, tax receipts, and charitable contributions could unravel the entire structure of cross-subsidization. Could it mean a reversion to the “old Aspen,” the laid-back, counterculture, easy-going, hippy-dippy, live-off-the-land Aspen?

Maybe so. But perhaps Aspen is facing systemic problems that can not be easily solved. Obviously, there are a great many demands on the area’s land, people, government and businesses. There has never been a consensus in Aspen that growth and development are desirable, even though the town has been dependent upon them. Now that certain limits are within sight of being reached, the already politicized town could become even more polarized.

The city government has always been composed and supported by year-round local residents, of course, who have always had a love/hate relationship with growth and development: the tourists and wealthy second homeowners bring the city great wherewithal, but they also bring great demands on the area’s carrying capacity and inevitably change the character of the place.

Of course, these conflicts have always existed, but as the stakes and money involved have grown, they have become more intense. It’s going to be an interesting next few years. See you at the Nell.

Dr. Roger Selbert is a business futurist and trend guy. He publishes Growth Strategies, a newsletter on economic, social and demographic trends, and is a professional public speaker. Roger is US economic analyst for the Institute for Business Cycle Analysis in Copenhagen, and North American agent for its US Consumer Demand Index.

December 22, 2008
How To Save The Industrial Heartland

You would think an economic development official in Michigan these days would be contemplating either early retirement or seppuku. Yet the feisty Ron Kitchens, who runs Southwest Michigan First out of Kalamazoo, sounds almost giddy with the future prospects for his region.

How can that be? Where most of America sees a dysfunctional state tied down by a dismal industry, Kitchens points to the growth of jobs in his region in a host of fields, from business services to engineering and medical manufacturing. Indeed, as most Michigan communities have lost jobs this decade, the Kalamazoo region, with roughly 300,000 residents, has posted modest but consistent gains.

Of course, Kalamazoo, which is home to several auto suppliers, has not been immune to the national downdraft that has slowed job growth. But unlike the state – which he describes as “a hospice for the auto industry” – Kalamazooans are already looking at expanding other emerging industries, including advanced machining, food processing, medical equipment, bioscience and engineering business services. Unemployment, although above the national average, is more than two points below the horrendous 9.3% statewide average.

As Kitchens notes, this relative success came through often painstaking and laborious work, a marked departure from the “magic bullet” approach to economic recovery that often dominates Michigan and other rustbelt states. In the past, Michigan Gov. Jennifer Granholm has touted ideas about developing “cool cities” to keep young people from bolting to more robust locales and, more recently, on the promise of so-called “green jobs” tied to sustainable energy.

“People don’t want to talk about ‘blocking and tackling,’” Kitchens suggests. “You keep your head down and keep pushing. It’s not sexy but it works over the longer term.”

For his part, Kitchens never much embraced the idea of coolness – a “cool Kalamazoo” effort even received $100,000 from Gov. Granholm as part of her strategy of promoting “creative urban development” as a way to keep talent in the state.

Of course, this gambit failed miserably almost everywhere, even before the recent economic meltdown. Nearly one in three residents, according to a July 2006 Detroit News poll, believes Michigan is “a dying state.” Two in five of the state’s residents under 35 said they were seriously considering leaving for other locales.

Kitchens does not express much faith either in Granholm’s latest gambit, developing Michigan into a green energy superpower. After all, states like Texas and California have a wide lead in these technologies and other areas, notably the Great Plains, possess a lot more wind and biofuel potential. And in terms of low-mileage “green” vehicles, the Big Three lag way behind not only the Japanese but even some European competitors.

So instead of believing in reincarnation or finding some miraculous cure, Kitchens believes places must rely on exploiting their historic advantages. In the case of Michigan, those are assets like a powerful engineering tradition and a hard-working and skilled workforce that can be harnessed in fields outside the auto industry. In addition, the area enjoys a cost of living significantly below the national average and far less than those in the coastal states.

“There’s no easy way to get out of the trouble the region is in,” Kitchens suggests. “You can’t make it by trying to be ‘cool places’ or be the green capital. Instead we have to focus on who we are, a place that has a great tradition of advanced engineering, and take advantage of this.”

So far this approach has paid off, leading to the creation of some 8,000 new jobs over the past three years. The region has focused both on bringing in new companies as well as helping existing ones expand. Perhaps most importantly, it has also raised a $50 million venture capital fund from local investors to help launch fledgling entrepreneurs.

The region also boasts an extensive set of business incubators, which seek to leverage the engineering skill of those just out of school or those who have left bigger companies.

The Kalamazoo experience shows one way out for not only Michigan but also other struggling Midwestern industrial hubs. Another promising example can be seen in Cleveland’s recently developed “District of Design,” which seeks to capitalize on the regions historic strengths in specialty manufacturing. It is all about taking advantage of the embedded DNA that exists in these once wondrously productive places.

This approach can even revive the residues of the automobile industry. There may be widespread and deserved contempt for the top management of firms like General Motors, but industry veterans repeatedly point out that the region – most particularly the area around Detroit – retains an enormous reservoir of engineering talent, which could provide the linchpin for regional recovery.

One recent sign validating this was the opening of a new $200 million Toyota research and development center in suburban Detroit. The key reason for making the investment, noted Japanese Consul-General Tamotsu Shinotsuka, was Michigan’s “abundant human resources.” If you are looking for “resources” who know the business of building cars and engines, locating in Michigan has certain logic.

Of course, this talent pool long has been available to the Big Three. However, as retired automotive engineer Amy Fritz has suggested, they have been ill-used by top management. American engineers, the British-born and educated Fritz suggests, are not inherently less talented than their Asian or European counterparts. They tend be more innovative but their creativity is often stifled by the short-term oriented management priorities of their bosses.

“With or without a bailout, the Big Three as we have known them will not be the same,” writes Fritz. “One or two could disappear. Others will no doubt shrink. However, the intelligence that exists within the engineering and industrial talent of Michigan remains. This is what the country should look to save from extinction, not the mediocrities who have ruled from highest management.”

Indeed, even in a future with a shrunken Big Three – and perhaps the extinction of at least one of them – the industrial heartland does not have to die. Nor does it have to become a permanent “hospice” for failed once-great companies. The way to a long-term prosperous future cannot be built by depending on the administrations of Washington or the political clout of the United Auto Workers.

Instead, Michigan, and much of the industrial heartland, should build a strategy that taps into culture that once made it the envy of the manufacturing world. These people are the key to any recovery, the ones who can both transform fading companies or start new ones. As the late Soichiro Honda once told me, “What’s important is not gold or diamonds, but people.”

This is the basic lesson of business that the current leaders of the Big Three, most Michigan politicians and perhaps too many on Capitol Hill have forgotten, or perhaps never learned. The industrial heartland may be down but as long as the talent and will is there, it is far from out.

If you do not believe it, take a little trip up to Kalamazoo, which may be quietly showing how to take the Great Lakes toward a new and brighter future.

This article originally appeared at Forbes.

Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.

December 18, 2008
Bailing out California, Again

If many of the nation’s governors have their way, the next agenda item for the spendthrift federal government could be a bailout of state budgets. According to a report issued on December 10 by the Center on Budget and Policy Priorities, 37 states face mid-year 2009 budget deficits, totaling $31.7 billion. As would be expected from its size, California leads the pack at $8.4 billion. However, California’s shortage is well above its share, at more than one-quarter of the total which is double its share of the population.

Yet it gets worse. Later, California Governor Arnold Schwarzenegger announced that the budget deficit had risen to $14.8 billion, which would take its share of the deficits to more than three times its share of the population. All of this is after a long and drawn out legislative process that was to have closed a previous $22 billion deficit earlier in the year.

For years, California boasted a strong economy, with the world’s leading technology, entertainment and agricultural industries. The state’s Legislative Analyst claims that California would be the 7th largest economy in the world if it were a nation. California is rich not only in the aggregate, but at the ground level. Only eight of the 50 states have a higher gross state product per capita. This means that California is per capita the richest large economy in the world. Thus, any bailout would be disproportionately financed by parts of the country that are often far less affluent.

How can it be that California stands in such tatters seeking a handout? Why are people from other states, at least 30 of which wouldn’t even rank in the top 50 economies of the world, being asked to prop up this dynamo?

The problem starts in Sacramento. California has been pitifully served by its state government. After missing the June 30 statutory deadline for balancing the 2009 budget, the legislature and governor spent the better part of the next three months doing everything they could to finish the job. In the final analysis they pretended to balance the budget with math that virtually no-one believed. That’s probably why there has been so little outrage at the new $15 billion deficit that has developed so quickly.

But the buck doesn’t stop with lawmakers. After all, California’s electorate has repeatedly sent the elected representatives to Sacramento that have produced this mess. In California the voters themselves seem oblivious to the financial status of the state.

This is likely to get worse before getting better. In the past voters could be counted on to vote down expensive new projects in hard times. But not anymore. In November they approved more than $30 billion in additional bonded indebtedness when they should have been asking for either a draconian spending cut or the tax increases. Californians will not be stopped from living beyond their means.

So how can this continue? One way is for the world’s richest largest economy to be bailed out by people in states that are generally poorer and have been more frugal than California. The state’s powerful congressional delegation, with such heavyweights as Speaker Nancy Pelosi and Henry Waxman, the new boss of the House Energy and Commerce Committee, are likely to see to it that the national interest is sacrificed on behalf of California.

The final irony here is the nation and indeed the world is already paying a heavy price for another exercise in Californian excess. The state is ground zero for the mortgage meltdown. It was here that house prices exploded. State and local land use policies provided the fuel for much of the increase, so that when demand increased in response to the profligate lending, the housing supply market could not adequately respond (unlike other higher demand parts of the country).

With the most bloated housing bubble in the nation, mortgage losses understandably were concentrated in California. California, which accounts for 12 percent of the national population has accounted for more than one-half of the aggregate loss in housing value. California house prices dropped at least 10 times as much as the national average since the peak of the bubble. When the people could not pay their mortgages, unprecedented losses occurred and house values plummeted from 25 percent to 50 percent in some areas. Enough people who had virtually no financial stake in their houses walked away.

California’s ability to spend every dollar the nation can print on its behalf should not be underestimated. Boatloads of federal money for California are likely to postpone any genuine efforts to improve California’s long run financial picture. The often used line about fighting a fire with gasoline has few better applications. A state that has thrown financial caution to the wind is not likely to adopt the necessary frugality with a new, national source of revenue. The special interests that have driven California’s spending into the stratosphere will not be more inclined to moderate their demands or to spend less lobbying money in Sacramento’s corridors. California’s taxpayers, perhaps the most anti-tax in the nation, are not likely to accept higher taxes if Washington can be counted on to pay instead.

There could be no worse signal to California’s dysfunctional governor and legislature than to bail them out. With the situation deteriorating daily, bailing out California could become a continuing national obligation – sort of like Iraq, but without the prospect of an exit date.

Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris. He was born in Los Angeles and was appointed to three terms on the Los Angeles County Transportation Commission by Mayor Tom Bradley. He is the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”

December 18, 2008
Financial Crisis: Who will Bailout the State and Local Governments?

The continual Illinois corruption scandals have created not only ignominy to the Land of Lincoln, but have now placed a negative ranking from Standard and Poor on its credit. If Illinois vies with other states for the title of most corrupt, it has plenty of company when it comes to financial disaster.

Although building for years, the impending collapse of state and municipal finance has been hastened by the growing financial crisis. The year 2008 will go down as one of the most turbulent years in the history of financial markets. Long established companies such as Lehman Brothers, Fannie Mae, Freddie Mac, and Citigroup have imploded. Large retailers like Circuit City have already filed for bankruptcy and, without federal help, huge companies like General Motors will join the parade.

Yet with all the turbulence in the private economy, there has been much less media attention on the coming bankruptcy of some municipalities and perhaps even some states. Many of us are taught in college finance classes that the yield on municipal bonds always has to be lower than U.S. Treasury securities, largely due to their exemption from federal income taxation. This normal pricing of municipal bonds no longer exists. Municipal bond yields, the last couple of months, are consistently higher than U.S. Treasuries. This tells us that the credit markets perceive great risk in lending to America’s cities. The perceived ability to pay back principal is now the operating rule in the credit markets.

As of this writing, Triple-A rated, Tax-Exempt General Obligation Bonds are yielding over 5% while the 30 Year Treasury Bond yields around 3%.This suggests that many communities and some states as well may be in distinct danger of default.

There’s a general pattern as to where the biggest problems lie: in those states and communities where public employee unions wield all but unlimited power. This is not so much the fault of unions – the purpose of every union is to gain higher wages for its workers – but in many states and cities there is no counterforce to their influence. This becomes a vicious circle. Local politicians overpay unionized government workers who make campaign contributions and organize “get out the vote” drives to make sure the politicians keep overpaying them.

The most recent famous example is the California city of Vallejo filing for Chapter 9 bankruptcy. George Will writes:

Joseph Tanner, who became city manager after this municipality of 120,000 souls was mismanaged to the brink of bankruptcy, stands at a white board to explain the simple arithmetic that has pushed Vallejo over the brink. Its crisis — a cash flow insufficient to cover contractual obligations — came about because (to use figures from the 2007 fiscal year) each of the 100 firemen paid $230 a month in union dues and each of the 140 police officers paid $254 a month, giving their respective unions enormous sums to purchase a compliant City Council.

So a police captain receives $306,000 a year in pay and benefits, a police lieutenant receives $247,644, and the average for firefighters — 21 of them earn more than $200,000, including overtime — is $171,000. Furthermore, police and firefighters can store up unused vacation and leave time over their careers and walk away, as one of the more than 20 who recently retired did, with a $370,000 check. Last year, 292 city employees made more than $100,000. And after just five years, all police and firefighters are guaranteed lifetime health benefits.

The recent news out of the state of California is no better. The L.A. Times reports that California’s budget deficit could reach $41 Billion by 2010. Can California continue to pay 3600 prison guards over $100,000 a year? It would be wrong to single out California. Many other places are on pace for financial ruin.

Massachusetts is another state where unions have hijacked the political process for the benefit of their members. Last year, The Boston Globe reported how lucrative rent-seeking can be:

Nearly one in 10 Massachusetts State Police officers made more than the governor last year, with 225 officers topping the $140,535 annual salary of the state’s chief executive.Four of the 2,338 state troopers were paid more than $200,000, and 123 others were paid more than $150,000, the salary of the governor’s Cabinet secretaries, according to payroll information obtained by the Globe under the state public records law.

And that brings me back to my home state of Illinois. We not only face an immediate cash flow crisis but also must confront an underfunded public pension fund deficit of more than $50 Billion, and the Blagojevich scandal has held up a needed $1.4 billion short-term bond offering. Chicago Public Radio reports the Illinois pension deficit is “larger than the state’s annual budget.” There is a clause in the Illinois State Constitution that prevents any state or local government worker’s pension from being cut. Will a federal bankruptcy judge have to come in and void a section of the Illinois State Constitution?

When the major credit rating agencies failed to accurately price in the risk of subprime mortgages, questions about their rating standards are now becoming quite important. If you can’t trust Moody’s, Standard and Poor’s, and Fitch, what should you be looking for if you want to own municipal bonds?

In the coming years, many municipalities and state governments will need to deal with the conflict between those who pay taxes and those who consume them. Government workers’ salaries come from the taxpayers: which means government workers aren’t net taxpayers. Cheap and easy credit might no longer be available to help pay for overpaid government workers.

This situation can be resolved in two ways. As in a bankruptcy proceeding, states and cities can work with unions to control costs and reduce obligations. Or they can – as Wall Street and Big Three have done – come to Washington, DC to beg. Once that happens, the long-term credibility of Washington’s debt will need to rise to record levels, with implications that are almost too horrific to contemplate.

Steve Bartin is a resident of Cook County and native who blogs regularly about urban affairs at http://nalert.blogspot.com. He works in Internet sales.

December 16, 2008