Local governments’ day of reckoning

Lynndee Kemmet Contributor
Font Size:

Lower property values, foreclosures, and decreased aid from cash-strapped states are adding up to a tough 2011 for many U.S. towns and cities — perhaps the worst since the Great Depression.

Consider property taxes, which account for 25 percent or more of most municipalities’ revenues. With home values still falling in many areas, according to Freddie Mac’s Conventional Mortgage Home Price Index, and an anticipated 1.2 million foreclosures in 2011, many counties and cities will fall far short of previous income projections.

Compounding their problems is sluggish consumer spending, which translates into lower sales tax revenues. According to a fall 2010 National League of Cities survey, 87 percent of the cities that rely heavily on sales tax revenues report fiscal distress.

On top of these stress factors is the loss of funding from the state and federal governments, known generically as revenue sharing. Municipalities generally receive around 40 percent of their income from these sources. But with state tax revenues down about 12 percent from pre-recession levels and most states facing fiscal 2012 deficits, these funds are being cut.

Many cities have responded by cutting budgets, including those for police, fire protection and education. Oakland, Calif.’s leaner police force can’t cover patrol beats. Detroit’s police force is abandoning entire neighborhoods. Many teachers are facing layoffs and the Education Commission of the States reports that school districts in over a dozen states have adopted a four-day week.

But even this may not be enough. According to the Federal Reserve, state and local debt is now running around $2.4 trillion, excluding health care and pension obligations, which are another $1 trillion in the hole.

The federal government’s response to the economic crisis has been borrowing. But this may not be an option for municipalities.

There already are signs that investors think holding municipal bonds, the primary means through which cities borrow, is risky, and there is a growing fear that interest payments will be delayed or maturing bonds will be declared nonredeemable.

This is evident in the fact that “muni” bonds now yield more than U.S. Treasury bonds. In January 2000, the monthly average yield on a two-year, AAA-rated municipal bond was 4.42 percent, versus 6.44 percent for a two-year Treasury. Now, the same muni yields 0.67 percent, versus Treasury’s 0.45 percent. In short, municipal bonds are now seen as more risky, so cities have to pay more to borrow.

Bond rating services also perceive the change. Moody’s Investors Service downgraded 279 state and local bonds in 2009, up from 81 in 2008, the largest downgrade in at least 20 years.

For some cities, wiping the slate clean through bankruptcy is beginning to seem like an attractive alternative. Late last year, for example, city officials in Hamtramck, Mich., adjacent to Detroit, said they would declare bankruptcy if the state would allow it.

Only about half the states do allow such Chapter 9 bankruptcies, though others are considering it.

Some states have created programs to help local governments avoid bankruptcy. In Harrisburg, Pa., which has defaulted on a $3.29 million bond payment tied to an incinerator project, city officials have relied on state support to make debt payments and even payroll. Such state programs may explain why more municipal bankruptcies haven’t occurred.

State officials may be justified in their fear that if one city is allowed to declare bankruptcy, more will follow. A conspicuous rise in local government bankruptcies certainly could hurt even reasonably solvent municipalities by further driving up borrowing costs.

But most states have their own financial problems and are in no position to take on the long-term financial obligations of ailing municipalities.

Even if the economy recovers more quickly than expected, the ripple effect is unlikely to reach local governments any time soon. If revenues remain stagnant or decline and investors grow more wary and demand payment on municipal bonds, local government budgets could crash.

If ever there was a year for municipalities to take a serious look at their budgets and how they do business, this is it. Taxpayers should demand it.

Lynndee Kemmet is a research fellow at the American Institute for Economic Research (www.aier.org), Great Barrington, Mass., and author of “Follow the Money: A Citizens Guide to Local Government.”