State Budgets Facing Financial Peril

I took this headline right from a CNN article. Many of these states are different than what I posted about just last month here. As I have stated on many occasions, state budgets lag the overall economy by at least year, usually two. This was a lesson learned in California where I worked for a County government and layoffs typically followed recession by 18-24 months. Governments can typically fill one or sometimes even two-year budget gaps using stopgap measures like borrowing money or pushing out expenses to a future date. Spread budget problems out to three years or more and things really start to pile up.

Why is this a big deal? Well, projected cuts to state budgets to make ends meet could lead to a loss of almost 900,000 jobs. These layoffs would begin next fiscal year which starts in July in most states.

It is absolutely amazing to me that there is a recognized economist in this article that is saying that there needs to be MORE federal stimulus to fill budget gaps in state budgets for 2011. Stimulus simply is a way to borrow against future production. It's really that simple. The solution to a spending problem isn't borrowing money to continue spending too much. The solution to a spending problem is to spend less.

I do agree with the economist that "budget cuts and tax increases will be a serious drag on the economy at just the wrong time".

My belief is that creative destruction needs to take place. This will mean a painful adjustment for some, however, it is the right path and it needs to take place in order for us to go through this. One of my favorite investment/economics writes often, "In order to get through this, we need to go through this." We are in for years of high unemployment. It will be the new normal. Central Bank economists are predicting that unemployment will continue to remain high for "years to come".

The last Pennsylvania budget gap was filled by federal fiscal stimulus funds. We are already $3 billion behind heading into the 2010-2011 budget. How that gets filled is anyone's guess. This kind of fiscal problem is going to trickle down to our District budget at some point. While Mt. Lebanon gets a huge majority of its funding from local tax dollars, even a reduction of 5% of state funding would be significant.

There is no easy way out of this for states or, eventually, for local governments. Belt tightening will have to take place at some point. The hope I have is that we make decisions that make the most long-term sense. If we can focus our decisions on future government entities and the impact our decisions today will have on these entities five and even ten (or longer) years down the road, then we can start to lay in stone a path for financial stability.

Thanks for reading.

James

Updated: State Revenues

Regular readers of this blog may remember an article I linked to back in June. It was a report from the Rockefeller Institute that discussed how State revenues were declining and predicted that states would end up having to again raise revenues and cut costs in the 2010-2011 budgets. I also posted my thoughts of the possibility of this happening last week.

Bloomberg has picked up the latest update from Rockefeller Institute and has this article:

State Revenue Falls Most Since 1963 on Incomes, Sales (Update2)

By Jerry Hart and William Selway

Oct. 15 (Bloomberg) -- U.S. state tax collections tumbled the most in almost half a century in the second quarter as the economic recession curbed levies on incomes and sales.

The 16.6 percent plunge was the biggest since at least 1963, the Nelson A. Rockefeller Institute of Government said today. For the 12 months to June 30, the fiscal year for most states, revenue declined 8.2 percent, or $63 billion, about twice what states got from the $787 billion U.S. economic stimulus package, the institute said.

State revenue has dwindled for two straight quarters and continued to decline in July and August, the Albany-based research organization said. Budgets for the year that began July 1 already face $26 billion of deficits, the Washington, D.C.- based Center on Budget and Policy Priorities said Aug. 12, forcing state lawmakers to confront additional spending cuts.

“We’re looking at a multiyear problem hitting essentially every state,” Robert Ward, the institute’s deputy director, told reporters. “It has happened during recessions before, but the depth of this decline is unprecedented in modern times.”

Collections dropped in 49 states in the second quarter as sales and personal-income taxes slid for the third consecutive period, the institute said. Income tax was down 27.5 percent and sales tax fell down 9.5 percent, its study said. Both categories fell by the most in 45 years.

“Many economists believe that the national recession has ended and that a tepid recovery is now underway,” Rockefeller analysts Lucy Dadayan and Donald J. Boyd wrote. “Unfortunately for states, an emerging economic recovery does not spell instant budget relief.”

‘Considerably More’

Figures for July and August for 36 early-reporting states showed tax collections down 8 percent, the Rockefeller Institute said. At least 17 states have announced budget shortfalls since July, with “considerably more” expected, Boyd said.

New York’s tax revenue from April 1 to Sept. 15 was $634.5 million below projections and $3.6 billion less than a year ago, Comptroller Thomas DiNapoli said yesterday. California reported last week that revenue trailed a forecast made less than three months earlier by $1.1 billion, or 5.3 percent.

States are anticipating more cuts to current-year budgets, already pared once to bring them into balance. Mississippi Governor Haley Barbour told managers on Oct. 13 to cut spending 5 percent because tax collections in the first three months of fiscal 2010 were 7.7 percent below estimates. Florida Governor Charlie Crist told department heads on Oct. 12 not to request more money for next year, when the state faces a $2.6 billion deficit.

“It’s clear that when governors propose their budgets in January, the vast preponderance will be looking for more spending cuts and tax increases,” Boyd said.

'Housing Market'

The main driver for the second-quarter decline was lower income-tax collections, Boyd said on a conference call, “most likely due to lower capital gains from market declines in 2008 and the bursting real estate bubble.”

Payroll-tax withholding fell 4 percent from a year earlier and estimated-tax payments made in the quarter fell 32 percent in the median state, he said.

“Real wages take 13 to 17 quarters to recover from the end of a recession,” he said. “It will take several years for states to bring spending into line with incomes.”

The study’s retail-sales index showed an 11 percent decline since the start of the recession in December 2007, he said. The second quarter’s 9.5 percent decline in sales taxes followed an 8.3 percent decline in the first quarter, he said.

Alaska’s tax income declined the most of any state, the study said, with an 86.5 percent drop because of lower oil prices. Vermont fared the best, with a 2.2 percent gain because of a one-time estate-tax settlement.

Local tax collections declined by 2.8 percent in the second quarter, the Rockefeller study said. That’s less severe than the state slowdown because municipalities rely more on property taxes, which rose “a surprising” 3.1 percent in the quarter, the report said.

Still, 88 percent of local finance officers said in a September poll by the National League of Cities that they’re less able to cover expenses than in the year before.

To contact the reporters on this story: Jerry Hart in Miami at jhart@bloomberg.net; William Selway in San Francisco at wselway@bloomberg.net.

A couple of points struck me. First, the fall in state revenues is of record proportions. However, while state revenues collectively declined 16.6%, local government tax revenues declined by only 2.8%. This disparity is due in large part to local governments being dependent upon local real estate taxes as opposed to income and sales tax. See the following chart from the Rockefeller Institute Report that depicts this:


Click on image to enlarge

Also from the report is the following statement:

Unfortunately for states, an emerging economic
recovery does not spell instant budget relief. As we have noted
previously, some elements of the economy that are very important
to state finances — particularly employment and wages — are
likely to recover more slowly than gross domestic product. In addition,
state tax revenue, when it does begin to recover, will be below
its earlier peak for at least several years and will not be
sufficient to support spending commitments that are now in
place. Despite the recovery, most states will face budget gaps this
fiscal year and next, and probably for at least one to two
additional years.

When I say state budgets are based on the past, this is exactly why. It is always a game of playing catch-up. Spending every dime in good economic times leads to the severe cuts we are seeing now.

If you like tables and charts and graphs, the Rockefeller Report is really a revelation. It contains a ton of information on every state comparing revenues, changes, and the effect of recent legislation.

One more point I need to make on this, and I did not see this in the Rockefeller Report, is that many states, if not most of them, used the Federal Stimulus funds to balance their budgets this year. I believe Pennsylvania used $3 billion to do just that. What this means is that every one of these states was already in a structural deficit before the new fiscal year began. Many states used that money as a one-time fill for their budget gap. The problem is, this is not a one-time revenue shortcoming. Tough decisions are going to have to be made.

Thanks for reading.

James

Pushing on a string

Banks around the country are trying to figure out whether to loan out the money they received from the TARP funds as Congress has repeatedly asked them to do or whether to save that money to prop up their crumbling balance sheets as bank regulators are asking them to do. They are finding that even if they wanted to lend money, they are having a hard time finding people who want to take it.

Please see this article from Andrew Jeffery "Americans to More Debt: Talk to the Hand- Our new allergy to credit is just heating up".

Washington just doesn’t get it: We don’t want more debt.

While congressmen berating bank CEOs for their unwillingness to lend out their bailout money makes for a nice media clip, it reflects the growing disconnect between our elected officials and any semblance of reality. Not that the relationship was ever particularly close - but lawmakers are floundering for good press while the nation’s economic future slips further and further from their tenuous grasp.

Bloomberg reports American consumers are wary of taking on more debt, as expectations about eroding economic conditions are forcing people, to *gasp* make responsible decisions about their personal finances.

Bloomberg cites Midsouth Bancorp (MSL) president C.R “Rusty” Cloutier, who says that, despite aggressive marketing, town hall meetings, and $20 million in TARP money, Midsouth's customers just aren’t taking out new loans (see full story here)

This is the rejection of debt Professor Depew speaks of when discussing the structural deflation we’re currently experiencing.

Credit is based on trust. And while conventionally we view this relationship as one in which the lender must trust the borrower to repay his debt -- at least to an extent that’s commensurate with the interest rate -- it does go both ways.

As lenders like Citigroup (C), Bank of America (BAC) and Wells Fargo (WFC) are increasingly being painted as corporate marauders out to rape and pillage the American public, would-be borrowers are wary of putting their financial future in the hands of these men of questionable repute. And with credit-card companies rushing to alter terms, it’s no surprise consumers are reluctant to extend themselves further.

Still, lawmakers are pushing through an economic stimulus package that depends, in part, on a willingness on the part of consumers to keep spending. Their delusion is only outmatched by their hubris - the belief that a bunch of self-interested politicos can coerce the average American into making ruinous financial decisions for the betterment of the country.

Floundering industries -- notably automakers and homebuilders -- are counting on government subsidies to encourage Americans to keep borrowing to buy their products. But what General Motors (GM), Ford (F), Centex (CTX) and KB Homes (KBH) don't understand is this: We just don't want what they're peddling. And we certainly don't want to borrow against it.

The transition from a debt-dependent, credit-drunk consumerist society won't be immediate: It's taken 18 months of financial panic for evidence of the shifting social mood to make its way into the mainstream.

But as the economic outlook continues to darken, the country becomes more disenfranchised, and the government grows ever-more addicted to sound bites and empty promises, reality will set in.

For the past 20 years, we've been blithely driving along an economic road that ends in a cliff. And that cliff is now in our rear-view mirror. We're tumbling, groping for any branch that can save us from the fall. But each one of these new government programs, bailouts and rescues simply tries to set us gently back on the road from which we only just plummeted.

We already know where that path ends, and it ain't pretty. What say we try another road?

How about it? How about WE try another road?

Thanks for reading.

James

Just Another Recession

I have written many times on this blog in regards to the current economic climate. Sometimes I come across a good bit of information that I feel is worthy of passing along.

Today's nugget comes from Speaker of the House Pelosi's blog. She is arguing that this is not just another recession. Of course, she has a stimulus bill to get passed so who knows. But, sometimes numbers don't lie. Please see the blog and interpret the chart below:

This chart compares the job loss so far in this recession to job losses in the 1990-1991 recession and the 2001 recession – showing how dramatic and unprecedented the job loss over the last 13 months has been. Over the last 13 months, our economy has lost a total of 3.6 million jobs – and continuing job losses in the next few months are predicted.

By comparison, we lost a total of 1.6 million jobs in the 1990-1991 recession, before the economy began turning around and jobs began increasing; and we lost a total of 2.7 million jobs in the 2001 recession, before the economy began turning around and jobs began increasing.

Tonight we have another discussion meeting regarding the high school project. One important note to make is that the architect update begins at 7pm instead of 6:30pm.

Thanks for reading.

James

The Aftermath of Financial Crises

Part of what I want to do on this blog is to let people know what I am reading. If you understand a bit about what I read, you understand perhaps a bit better how I come to my decisions. Last night I came across a research paper entitled "The Aftermath of Financial Crises" written by Carmen Reinhart (University of Maryland, NBER and CEPR) and Kenneth Rogoff (Harvard University and NBER).

The authors had previously done research into the aftermath of financial crises in developing countries and this paper expands to include developed countries as well. It is a relatively short read (13 pages) and is quite informative. You don't have to believe everything they say, but you should respect it. I believe there is a consensus out there that we are right in the middle of a pretty severe financial crisis. These authors are ranking what we are going through now right up with what they call the "Big Five" post-war crises that include Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992.

They make some very interesting points regarding expected changes in employment, output, equity prices, housing prices and more. Below is an excerpt:

Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes.

Interestingly, the main cause of debt explosions is not the widely cited costs of bailing out and recapitalizing the banking system. Admittedly, bailout costs are difficult to measure, and there is considerable divergence among estimates from competing studies.

But even upper-bound estimates pale next to actual measured rises in public debt. In fact, the big drivers of debt increases are the inevitable collapse in tax revenues that governments suffer in the wake of deep and prolonged output contractions, as well as often ambitious countercyclical fiscal policies aimed at mitigating the downturn.

It's interesting what they say here. That third point about the real value of government debt exploding is certainly a path that we are embarking upon. What is it that we have now, one $700 billion stimulus package down, and a one trillion dollars left to go?

It's been strange hearing economists predict that the way we solve this crisis is to do what got us in this crisis in the first place. We spent too much, we borrowed too much, we leveraged too much. And now the government has reduced interest rates to 0% which necessarily punishes those who wish to save and encourages people to borrow. The government keeps handing out cash to banks and asks them to lend more. The problem is, the American consumer is tapped out. There is a retrenchment of the consumer happening now that is of a degree not seen in some time. How long that retrenchment (and the reduced consumption that goes along with it) lasts will determine the severity and length of this economic downturn.

It is often said that history repeats itself. I prefer saying that history rhymes. I think that is more accurate. To that point, I would like to point out a series of papers written by Ludvig Von Mises. Von Mises was a preeminent economist that was part of the Austrian school of economics. Most people today are taught Keynesian Economics which were developed by another economist, John Maynard Keynes. Keynes is the inventor of all those supply and demand curves you learned about in high school and perhaps in college as well. Von Mises did not agree with everything about the Keynesian school of economic thought. Through his papers published before, during, and after the Great Depression, you can get an idea of what he believed to be the causes of, and the cures to, the Depression. There is a series of papers out there called "The Causes of the Economic Crisis and Other Essays Before and After the Great Depression". The essays contained in this document were published between 1923 and 1946. The last paper from 1946 has a working title of "The Trade Cycle and Credit Expansion: The Economic Consequences of Cheap Money". The conclusions from that paper really allowed me to get a handle on what we are going through today and what effect government intervention may have.

The point of this is to say that the large majority of economists that are prominent today come from the Keynesian school of economic thought. When we hear people talk about a huge majority of advisers and academia folks agreeing on the best way to get us out of whatever malaise we are in, it is because most are believers in the Keynesian school of thought. Those that follow the Austrian school of economic thought were proven to be correct about a lot of the causes of the Depression. Those that are Keynesians believe that we can stimulate demand (and therefore employment and production) by embarking on massive government spending programs. While these programs may make us feel good in the near term because we can see that our government is trying to do something, the long-term consequences of such programs is astounding.

I am hopeful that the Austrian school of economic thought will start to make its way into the mainstream in 2009.

What does this have to do with anything on the School Board. Well, as President Bill Clinton would say, "It's the economy, stupid".

And just in case you were wondering, yes, I do read those things for fun! I love reading material from people that were closer to the history than I am. When I wanted to read about the US Constitution, I read Charles Austin Beard's The Republic first published in 1943. When I wanted to read about the underpinnings of capitalism, there is no shortage of books out there. I chose (among many others) Adam Smith's The Wealth of Nation's (1776), John Chamberlin's The Roots of Capitalism (1977), and Jude Wanniski's The Way the World Works (1978). These books come from a different time and from a different perspective. To me it is fun to see how well these authors have predicted what our world would look like today.

Thanks for reading.

James

Almanac Editorial

There was an interesting editorial in this week's edition of the Almanac. It touched on a lot of issues that need consideration when thinking of the Mt Lebanon High School project.

Here is the entire editorial:


Click on image for link.

Other articles keep popping up in local papers describing how the nation's credit crunch is affecting working and middle class families like the ones that live in Mt Lebanon (kudos BlogLebo for finding that story). While I personally believe that Mt Lebanon, and Pittsburgh more generally, will be spared the worst of the housing downturn, that does not mean we will escape unharmed. With so much of the nation's economy dependent upon consumer spending and that spending supported in large part by ever increasing home prices in recent years, the downturn we are experiencing now could last until home prices rebound. Many economists are now predicting housing prices to continue to drop into 2009 before stabilizing This means it might be some time before we see a true recovery.

This housing recession will have an impact on all local economies as well. We have already seen a number of states, including most of Pennsylvania's neighbors, cut back severely on spending or raise significant taxes to fix budget shortfalls. Please see the following paragraph in the linked article from the Center on Budget and Policy Priorities:

"The bursting of the housing bubble has reduced state sales tax revenue collections from sales of furniture, appliances, construction materials, and the like. Weakening consumption of other products has also cut into sales tax revenues. Property tax revenues have also been affected, and local governments will be looking to states to help address the squeeze on local and education budgets. And if the employment situation continues to deteriorate, income tax revenues will weaken and there will be further downward pressure on sales tax revenues as consumers become reluctant or unable to spend."

While Pennsylvania does not make the list of 29 states in the above article, our latest State budget included adding new debt. Debt service payments increased by over $35 million annually in this latest budget to a grand total of $905 million per year.

The point of all this is to say that we are embarking on a project of a grand scale, no matter what option is chosen, and that we must consider where we are headed as a community economically when discussing what we could, should, and must do.

As always, I welcome your feedback to james.fraasch@gmail.com

James