State and Local Finance and the Storm Surge of the Housing Bust

Hurricane Katrina was violent and frightening, but it was the relentless pounding of storm surge that forced the flooding that caused the most serious damage to property and degradation to communities. In the same way, the subprime crisis which has roiled the financial markets may be violent and frightening, but it will be the storm surge of secondary effects on house prices, employment, consumer credit, personal consumption and tax revenues that does the real damage to individuals and communities.

We know that mortgage equity withdrawal fuelled a huge proportion of spending growth in the wageless and jobless recovery of the past six years. Except in the executive suite, wage growth was stagnant in real terms for most workers and job growth was the most anaemic of any post-WWII recovery. It was the massive appreciation of house prices, locked in a spiral with easy credit, that financed growing consumption expenditure, supporting ever rising corporate revenues and executive compensation.

With the collapse of the housing bubble, consumers can no longer borrow against house price appreciation to fund consumption. That much is now clear.

What is less well appreciated is that consumers were not the only ones using houses as proxy ATMs. Municipalities and states that rely on developer fees and real estate taxes for a significant proportion of revenues will be finding money tight too as the housing bust gets entrenched and credit tightens.

This is hugely important to the civil fabric in the United States. As Max Sawicky explained in his 1999 paper, The New American Devolution: Problems and Prospects:

If we exclude Social Security, Medicare, net interest on the federal debt, and defense from the total expenditures of federal, state and local governments in the United States, 80 percent of what remains is administered by state and local governments. In addition, most public investment (infrastructure, education, and training) is financed by state governments, and most infrastructure facilities “reside” in the states.

Between 1980 and 2005, the average per capita state and local government expenditures across the 50 states doubled from about $3,500 to just over $7,000 in inflation-adjusted 2006 dollars. Over the same period, debt issued by state and local governments grew from about $300 billion to more than $2.2 trillion.

Falling income taxes, corporate taxes, sales taxes and property taxes will quickly put pressure on overextended state and local budgets – and then on their debt service. Those states and municipalities that leveraged their revenues to raise expenditure will be the first to get in trouble.

Just as some home owners played it safe, paid off the mortgage, and let the increased value of their homes remain untapped, some cities are better positioned to weather a housing and credit slump.


S&P notes that although all cities are impacted by housing price declines, each city varies in the amount of money it generates from property taxes. Dallas, for example, gets 42% of its municipal revenue from property taxes; Philadelphia, just 6%. Moreover, cities in California may not be hurt as much as one would think because increases in home appraisals have been limited under the state’s famous Proposition 13.The report concludes that most of the big cities should weather the housing bust. Among big cities, Phoenix has probably seen the biggest drop in home prices and sales, but S&P concludes that previous conservative municipal management coupled with recent action by officials there to trim spending should allow Phoenix to maintain its triple A credit rating. That’s the highest rating among the big cities (another surprise there).

It takes a while for a housing bust to show through in tax delinquencies and falling municipal revenues, but it is beginning to come through in figures now. While data is hard to find nationwide, the following data from Clark County, home of Las Vegas, may illustrate the trend elsewhere:


Delinquent parcels up

Fiscal year*

Delinquent parcels





Multiple-property delinquencies rise

Fiscal year*

Share of owners with 5+ delinquent parcels





Percent of delinquent taxes increases

Fiscal year*

Total levied

Total delinquent

Percent delinquent

Penalties owed


$2.2 billion

$51 million


$7.7 million


$1.9 billion

$27.8 million


$4 million

*Fiscal year runs July 1-June 30. Source: Clark County Treasurer’s Office

Particularly worrying is the growth in delinquency by those owning more than 5 parcels, usually developers, real estate investors and banks. Since all of these are in the front line of the subprime meltdown, the squeeze on municipal revenues is unlikely to recede soon.

There are no good options for reducing state and local expenditure. The biggest drivers for growth are not easily negotiated: education, emergency services, police, corrections, pensions of state and local employees, health care and early retirement expenses, federal and state mandates that are not fully funded, assessments by independent authorities not subject to central budgetary controls. Add to that entrenched redundant layers of bureaucracy at every level, resistance to standards and collaboration, and antagonism between federal, state and local treasurers, and an easy, quick resolution to the coming problems appears remote.

Defaults on municipal bonds to date in 2008 already exceed three times as much as recorded for 2007. From Joe Mysak at Bloomberg:

So far this year, $736 million in municipal bonds have defaulted. That doesn’t necessarily mean they didn’t pay investors; they may have just drawn down reserves. That’s what happens just before they stop making payments to bondholders.

During all of 2007, only $226 million in municipal bonds defaulted, according to the May edition of the “Distressed Debt Securities” newsletter, published in Miami Lakes, Florida. . . .

We’re probably going to see a lot more munis default this year and in the years to come, because of the subprime crisis and maybe, just maybe, because of the high price of a barrel of oil.

Municipal bond insurance was considered the safe and stable part of the portfolio of monolines. If municipals start to default in any significant number, the nightmare of monoline impairment will get much, much worse. The monolines were founded to provide credit enhancement to municipal bonds. Finding a replacement mechanism is now an urgent priority.

Two entrants of note are Calpers and the Federal Home Loan Banks. Calpers is doubling its municipal credit enhancement programme from $5 billion to $10 billion. The Federal Home Loan Banks are pushing for legislation that would allow them to write letters of credit based on their AAA ratings to support municipal issues. As the FHLBs extended over twice as much as the Federal Reserve in bank credit last year, perhaps they need another source of revenue to diversify their risks – or maybe they serve as a convenient mechanism to socialise bad debts on the federal taxpayer.

Additionally, the ratings agencies are being pressured to adjust their ratings for municipal bonds to resemble those used for corporates and sovereigns, reducing the need for credit enhancement. Investors may prove sceptical of a massive upgrade of municipals in the face of rising revenue and expenditure mismatches. The rating agencies don’t have quite the credibility they held just a few years ago, and any sudden moves will be subject to fierce scrutiny now – and maybe litigation later.

The subprime crisis hit like a storm. As the surge builds against the fiscal defenses of states and local municipalities, the likelihood is that some of the bulwarks of civil government will collapse. The massive debt at all levels of United States government limit the options for responding to local crises in the face of rising credit constraints. Many will muddle through, but any disruptions to education, policing, emergency services, healthcare and social interventions may have tragic long term consequences.


I had the great pleasure of meeting and hearing Professor Roubini in person this week in London. He gave a tour de force presentation of the American and global financial situation which held few surprises for those who read his blog regularly, but came as a wake up call for other policy makers, bankers and journalists in the room.

Perhaps one surprise was that he smiles often, even when presenting a rather gloomy sketch of coming events. Despite being “the biggest bear on Wall Street” he comes across as warm and charming. He won several appreciative laughs, despite a sombre message that, “the UK is effectively in slow motion a small version of the United States.” (Ouch!) He was upstaged only by Sir Samuel Brittan, eminence grise of the Financial Times, who began an observation with, “May I introduce a note of pessimism . . . “

I bought Professor Roubini a pint of Spitfire at a City pub afterwards. It is an odd sensation to be facing someone as a near stranger in a pub who you have followed on a blog for a substantial time. The reality of a person never quite matches the blog persona, but the familiarity and respect already established yield a ready friendship.

20 Responses to "State and Local Finance and the Storm Surge of the Housing Bust"

  1. villager   June 20, 2008 at 6:16 am

    Wow, what you have written about the financial impact to be experienced by state and local governments contrasts so sharply with what I read in the Asian Times about the "richness" of the military bases being built in Iraq by the US government, that are the size of small towns, have sidewalks in a country that is largely potholes. The writer of the article suggested that the US citizen will be dismayed by the comparison of what his national government has built in Iraq and the response or lack of response to New Orleans following Katrina. Your article gives more reason for dismay!

  2. Guest   June 20, 2008 at 9:33 am

    London BankerYes – you make a very good point about the growing impplosion in state budgets across the USA It’s very likely that these states will have no choice but to increase revenues from taxes. There is nothing else they can do. But they find themselves in a dilemma – because the price of food and energy are already skyrocketing across America. So I don’t see how they can add fuel to the fire by further taxing the basic necessities. More likely, we will see an explosion in both state and government taxes aimed at penalizing "luxuries". Certainly, tobacco, alcohol, expensive clothes, jewelry and other expensive items could easily be hit. A reversal of the trend (under Bush) to lower death and estate taxes is also increasingly likely. Increased taxes on capital gains … very likely. But probably we won’t really see this "tax explosion" until after the elections at the end of this year. You can be sure that the experienced politcians know that it’s coming. They are just not talking about it.PeteCA

  3. TA   June 20, 2008 at 11:26 am

    Timely, relevant and as unusual, well said.Some may not appreciate another variable impacting local municipalities’ ability to survive; their ability to derive property tax revenue at inflated assessed values.Many municipalities rode the wave of ever inflating property values by widening their tax base through reassessment. However as values plummet, property owners are likely to seek relief through measures such as reassessment.Municipalities will be in a straight jacket; shrinking tax base, hostile taxpayers, and entrenched services.

  4. Guest   June 20, 2008 at 11:44 am

    Somebody needs to start telling the truth out loud. Thanks for doing it.

  5. Anonymous   June 20, 2008 at 12:02 pm

    many muni auctions failed but municipals had to pay auction fees to Wall Street firms. Health, education, infrastructure spending will take a hit. Wall Street has definitely socialized the losses. Congress must act soon to pass the housing bill to prevent foreclosure, and provide assistance to state and local governments

  6. Guest   June 20, 2008 at 12:10 pm

    Housing and auto sector oriented states have been hard hit. It is interesting to see exports and oil oriented states still holding up, but depends on for how long the dollar weakness and oil price rise continue

  7. Miss America   June 20, 2008 at 12:22 pm

    Mr MaGoo, you’ve done it again!!! Thank you LB, I was set to have a nice weekend of sleeping in and watching Saturday morning cartoons… but now I got this to worry about! The storm. …and then the surge! Both are destructive forces of nature. But just as natural as the destruction, is the recovery. The waters recede. What’s left evaporates. POOOF!!! Into thin air.The pain will be felt in this economic tidal wave, but eventually… POOF! (or should I say: “P,OOO,OOO,OOO.OOF)We are faced with an economic crisis that is like no other. Sure there may be parallel’s to past crisis, but none are the same. The variables are always different. Negative savings, 20-30% drop in national RE value, Derivatives that are more valuable then the Sun, and worldwide hyperinflation that could be 1 meal away for many. The game has changed, and so will the ultimate solution. The markets will recede. (all markets!) …and then POOF:Evapor-flation! Houses are the hermaphrodite of wealth! The biggest asset and biggest debt most Americans have. The eventual cure for the individual will come with the write down of their debt. As the equity disappears, so will the amount owed. The forgiveness of the debt will be forced, as the equity is held ransom. All for the price of a roof over your head and a functioning society. Why stay??? …because when the tide recedes and the market for houses once again finds its “PURPOSEFUL” value, (as a home/investment, rather then a speculative investment) the equity will return. Sure, no one (including me) favors a bailout. But this debt forgiveness is bigger then Wall St. Sure, there are companies that are “too big to fail”, but a society failing is unacceptable.There is no outright “fair” cure. There will always be some assclown out there that will profit off of the sweat of others and that is unfortunate for the herd. …but then again, what’s best for the herd is a little thinning. Eventually the herd will be stronger for it. Recovery the way nature eventually dictates.For a moment there (while thinking about our future), I had the blues. …but then I remembered, it’s all just a silly game of life. So tomorrow, it’s back to the Saturday Morning Cartoons for me and my 2 little ones! We’ll catch an episode of Dora and Wow Wow Wubsy while my house’s equity fades away. …and if times turn bad for us, we’ll eventually watch our debt decrease through the forgiveness that will have to happen. Yours truly, Smurfette. Aka -Rich H Aka – Miss America (or in my baseball circle Aka “the chainsaw”)OK… this post will have to go down as one of my most value-less contributions to humanity! I guess that means I’m ready to run for public office!

  8. DocBerg   June 20, 2008 at 12:29 pm

    As a former city administrator, I have been watching this storm brewing since the turn of the century. I was especially concerned because I had a bunch of municipal bonds that would require rolling over as we did not have the funds to pay them off. Then there were the major infrastructure improvements needed, and maintenance that we could ill afford. The area where I worked was being savaged by the fatal combination of labor union idiocy and globalism. From what I can see from where I live now, local government management has its collective head in the sand, and fervently believes that this downturn will be mild and of short duration. Here in Illinois, property taxes are set by a 3 year moving average of property value assessments, so the falling values will not hit immediately. But if people are not paying their mortgages, chances are that they are not paying into escrow for insurance and local taxes. This is going to be painful much more quickly. In my locale, the school district hoodwinked the taxpayers into a $110 million bond issue, and will soon be seeking another for at least $115 million. The city government wants to bond out several TIF projects for about $200 million. The county needs a new jail (despite there being no crime problem here…) and that will me many more millions of dollars. The population of the city and school district is somewhere around 60,000. That is a lot of debt for that number of people, and there is not that great of a tax base here. The main employer is a state university. If anything London Banker, you are grossly understating the severity of the problem. Something is going to have to give, and I suspect that the first will be the ridiculous level of local government debt for grandiose projects, and the next will be the public employee unions. I hope to relocate to my property in a remote rural area before all of this hits the fan.

  9. London Banker   June 20, 2008 at 5:26 pm

    @ DocBerg and K in TXIt’s always satisfying to have someone with infinitely more expertise confirm my shallow prejudice and conjecture. Many thanks for substantiating what I could only guess about the dire state of local finance. Hundreds of millions of debt and 60,000 residents? In what parallel universe does that make sense?@ Miss AmericaIt is truly flattering to have Miss America’s praise for my humble efforts here. As I recall, Scooby Doo did wonders to lighten the burden of the 1970s, so I don’t see why Wow Wow Wubsy should be distained today. Enjoy! We take such pleasures as life affords, and if we are grateful we are happy.@ Villager, PeteCA, TA, Guest and AnonymousMany thanks for your kind words. I rather think that community spirit and collective will must pick up the slack for finance as things wind down. Your joining us here is a good indicator that there are those willing to pitch in and create community.

  10. London Banker   June 20, 2008 at 5:31 pm

    Reuters US Online Report Top NewsJun 20, 2008 11:05 ESTNEW YORK (Reuters) – Surging fuel prices are forcing cities across the United States to cut back on services and dip into cash reserves to keep their fleets on the road, according to a survey released on Friday.Ninety percent of the 132 mayors surveyed by the U.S. Conference of Mayors reported that climbing fuel prices have had a significant impact on city budgets and operations.The average retail price of diesel used in city buses and garbage trucks has shot up 65 percent over the past year. Gasoline prices jumped about 35 percent over the same period, as many local governments are feeling the pinch of the wider nationwide economic slowdown."It’s just a snowball. It all hits at once. So, governments, mayors are having to make tough choices," said Mayor Douglas Palmer of Trenton, New Jersey."Everything is on the table except for a reduction in public safety."Just under a quarter of the mayors surveyed — 23 percent — said they have been forced to slash spending for other programs in order to pay mounting fuel costs.

  11. RGE 1   June 20, 2008 at 7:13 pm

    London Banker I always look forward to your insightful posts. I wrote a report a few months ago about the short term response by municipalities to revenue shortfalls. One way cities and state governments are trying to raise revenue is by instituting and raising fees for all types of services. Fees and fee increses are very easy to pass, because they are aimed at a narrow set of users and they are generally small, but when broadly and systemically applied they can raise a great deal of revenue. Parking fees, bridge tolls, processing fees, late fees, impact fees, code violations, the posting of bonds for new construction, garbage fees, water and sewer fees. They are certainly taxes, but they are stealthier.

  12. London Banker   June 20, 2008 at 10:57 pm

    @ RGE 1Stealth fees by municipalities are not news to me! In 1990 virtually all parking in London was free and there was virtually no enforcement of speeding or stoplights with fines. Today fees and fines are massive sources of revenue for the state in Britain. Parking costs the equivalent of $15 per hour in central London, and is charged in every small town at lesser rates. Cameras have been placed on every major stretch of road and many stoplights, and now even bus stops, to catch the unwary with swinging huge fines. My guess is that the total government "take" from earned income is almost as large today as in the high income tax 1970s, but fees, fines and excise taxes (liquor, cigarettes, petrol and diesel) make up a very large proportion. As we are in deficit already even with these measures, I do not see them offering a ready solution to a pending financial crisis.

  13. DocBerg   June 20, 2008 at 11:12 pm

    Most of the so-called "good government" movement grew out of the Progressive Movement. These people decided after reading Immanuel Kant, Marx, and some other luminaries, that progress was indeed inevitable, and that problems can be solved once and for all. A good barometer of this viewpoint is Woodrow Wilson’s 1887 essay on public administration. The only philosopher he quotes in this work is Hegel. He believes that it is possible to run a government like a business, and that one can splice the Prussian bureaucracy into the American political system readily and without having to go through the grim process that Prussia had to undergo. So, with liberal democracy in place, the problem of tyranny is banished forever. Next, we can abolish poverty, disease, and some of his modern disciples are trying to also eliminate the problem of death. So, there is no danger involved in the surveillance state, since tyranny is a thing of the past and we cannot turn back the clock. High taxes and fees are a small price to pay for an eternal paradise on Earth. Foolish, yes, but these views are very widely held. Especially in academic and governmental circles.

  14. wormyboy   June 20, 2008 at 11:21 pm

    Nice job LB. I thought you were an average Joe, until I read your profile. Thanks for taking the time to share your thoughts with us average joe’s.

  15. RGE 1   June 21, 2008 at 10:34 am

    London Banker, I completely agree that fees are not new and will in no way can avert a pending financial crisis, but there are many Americans that are not used to the scope and level of many of these fees. While large expenses like fuel are felt easily and immediately the cumulative affect of all these small charges from the public and private sector are causing much pain in the US and the worst part is most people while noticing it, don’t think that it amounts to much. (It’s just $5.00 or $2.00 or $10.00) While a tax increase can cause a revolt, the state will try to squeeze every possible bit of revenue it can from it’s citizens by any means. It is death by paper cut and the real victim in the end is public trust.

  16. DocBerg   June 21, 2008 at 4:20 pm

    Interestingly, probably the least hated local tax is the sales tax. It is highly regressive, but it takes its revenues normally in smaller bits. Big ticket items make their sales tax more noticeable, but most people do not make many of these. If a purchase is made on credit, most seem to be worried about how much the monthly payment is, not the tax bite. The real estate/property tax is disliked as that is normally paid in two rather large installments. One of the most hated taxes is the personal property tax. The reason Illinois got a new state constitution in 1970 was because it allowed for the repeal of this tax. Now, there is a state income tax, and some home rule municipalities have one, too. While the sales tax is the least hated, it also can be compared to the death of the thousand cuts. Over time it creates a substantial burden. What I see happening now here in the midwestern U.S. is rising expenditures and public sector pay, colliding with flattening and even declining revenues. This is the case even in wealthy places like DuPage County, Illinois. I expect that the inevitable expansion of government, is going to come to a screeching halt momentarily. I do not expect to see business as usual happening again in my lifetime.

  17. Rich   June 24, 2008 at 9:29 am

    I don’t dispise the Wubster. Nor Widget or Walden.For the record… Wow Wow Wubsy is the BEST new cartoon going. I just wish there were more then 20 episodes!!!You heard it here first.Miss Americap.s. I like hidden backposts.

  18. London Banker   June 25, 2008 at 6:11 am

    @ Miss A-RichWalden is not to be despised, although otherwise your post is more opaque than is usual even for you. It is sunny today in Tallinn, but much to windy to venture from the harbour. We are off to the nearby TV tower which features bullet holes in the base, marking the most recent attempt at empire in this much traded corner of the Baltics. Those particular bullet holes date from the Soviet resistance to Estonian independence in 1991 – not so long ago. Today Estonia is prosperous, independent and proud – and part of the European Union.

  19. Taxpayer   June 27, 2008 at 6:34 am

    "Peak Oil" is getting good coverage in the media lately.The peak oiler tactics are much like those the realclimate gang use.Doom and gloom sums it up."Peak Oil" is supported by "Big Money""Peak Oil supporters include billionaire hedge-fund manager Boone Pickens and Houston investment banker Matthew Simmons." numbers are, at best, very rubbery figures.For example,"The Iraqi Deputy Prime Minister told The Times that new exploration showed that his country has the world’s largest proven oil reserves, with as much as 350 billion barrels. The figure is triple the country’s present proven reserves and exceeds that of Saudi Arabia’s estimated 264 billion barrels of oil." field that I participated in wildcatting, was initially said to have reserves which would last for around 20 years.That was in the sixties, it is still going strong.Reserves are usually proven up to the level that is enough to satisfy the financial backers of the project.They have little to do with actual recoverable hydrocarbon available.From where I stand, the money is going to run out long before the oil ever does.Re the cost of oil production, a major expense is seismic exploration.The costs in this field have been reduced dramatically with the advent of cheap number crunching.Exploration costs have reduced from around $16/bbl to $4/bbl.(You will have to take my word for this, I can’t find a link, check with your local multinational oil company or seismic services provider, YMMV.) :-) Tar sands and shales also hold enormous liquid hydrocarbon reserves."The reserve that is deemed to be technologically retrievable today is estimated at 280-300 billion barrels. This is larger than the Saudi Arabia oil reserves, which are estimated at 240 billion barrels. Total reserves for the province, including oil not recoverable using current technology, is estimated at 1,700- 2,500 billion barrels.The industry has been producing oil for as little as $24 a barrel." Realclimate is backed by Environmental Media Services, check them out.One of the tricks is to give your organization a name that appropriates the moral high People for the Ethical Treatment of Animals, (like the rest of us aren’t!), or Mothers against Drunk Driving or Earth First!."Real Climate" is a staged and contracted production, which wasn’t created by "scientists", it was actually created by Environmental Media Services, a company which specializes in spreading environmental junk science on behalf of numerous clients who stand to financially benefit from scare tactics through environmental fear mongering. There you will find the word "model" used a million times, for the entire basis of the Global Warming Hoax is based on computer modeling ( not climate science ) which has thus far failed to predict anything accurately since day one…..Jim Peden — Jun 24 2008 07:52 PM"RealClimate jumped the shark when the resorted to directing folks to known far left smear sites as an answer any time a name of a critic of the AGW theory was mentioned… I view AGW as the 90’s theory that co-opted the green movement…Hopefully that leech will be removed before the green movement is sucked dry.Jim Johnson — Jun 24 2008 09:12 PM paraphrase Laocoon, "Beware of geeks bearing models".Now don’t take this to mean I am for waste, profligacy etc, just the opposite, "nothing in excess" is a belief that has stood the test of time for me.And I am definitely not for scaring or pressganging people into adopting my frugal, some say, miserly ways.Conspicuous consumption has its place, but like most things, it can kill.Not the sort of thing I wish to lay down my life for.