oftwominds-Charles Hugh Smith

The Housing Bubble - Infrastructure Connection

Longtime correspondent UKC recently offered some disturbing speculations about the consequences of the housing bubble bursting and the decline of the U.S. infrastructure:

Just some thoughts on how the decline in the municipal tax base due to the housing crisis might play out. My feeling is that the general consensus (amongst those who think about such things at all) is that the various governmental organizations will cut back but most of the really essential stuff will be maintained. What if political considerations cause the municipalities to make unwise decisions which have serious long term consequences?

Governmental organizations are not known for their long sightedness, and may well choose to cut based along fault lines in their own internal power structures rather than providing essential services. For example, they may decide to decimate the road repair budget in order to avoid an expensive battle with the unions in other areas. What effect could this have? Well, it might balance the books in the short term - but it might have serious knock on effects. I would submit the article below (from the kunstler site) in which the corresponent from South Africa blames poor upkeep on the roads for the power companies recent inability to keep the lights on.

SOUTH AFRICA IN THE PREMATURE LONG EMERGENCY

If this sort of infrastructure degradation appears, it could be very hard (for free enterprise or public) to provide many of the fundamental services we expect (water, electricity, gas, sewage, fuel and food distribution etc). Personally I have do not have too much faith in the governments ability to do the necessary but unpopular things. It's something to think about.

On a related topic, the recent failures in the Municpal Auction bond market are very serious stuff. Seems the munis are finding it very hard to sell new paper or roll over the old debt. This does not bode well for the future - I suspect very, very soon municipalities will only able to spend what they can raise from taxes because nobody will lend them any money. This will be true for corporations and people as well. Credit will dry up and the velocity of money in the system will decline dramatically.

Remember our many conversations about exurbs falling apart? Here's an interesting article regarding the decline of an exurb and also the popularity of walkable urban centers. Who'da thunk it.

The Next Slum? (theatlantic.com)

As always, I do enjoy your writing - read the site every day."

Thank you, UKC, for yet another thought-provoking set of ideas.

Thanks to longtime correspondent J.F.B., we have an up-to-date story on the muni meltdown:

Auction-Bond Failures Deplete New Hampshire Fund

The $330 billion market for auction-rate securities imploded in February after dealers who supported it for more than two decades stopped bidding for bonds investors didn't want, pushing interest costs to as high as 20 percent. Since then, almost 70 percent of the auctions for debt sold by cities, colleges, student lenders and closed-end funds have failed each week, according to data compiled by Bloomberg."

If Municipal bonds become difficult to sell, or require hefty premiums, that will have an enormous impact on local governments' ability to pay for infrastructure repairs. Here in California, most of the infrastructure work is paid for by bonds: school repair, park expansions, etc. Road upkeep is supposed to be paid out of gasoline tax revenue but these funds have (until new laws were passed) been diverted to other "needs."

UKC aludes to a battle I have long predicted: the one between stretched/angry taxpayers and the public unions whose generous pension and benefits are already breaking municipal budgets:
Boomers, Prepare to Fall on Your Swords (June 2005)
"Retirement": The New American Elite? (June 2005)
The Chickens Are Coming Home to Roost (February 6, 2006)

In a nutshell: Federal entitlements (Medicare and Social Security) are set to balloon to 22% of GDP as Baby Boomers retire en masse. This is roughly the same share as the entire current Federal budget consumes. That implies the Federal Government will need to suck out 40% of the GDP if these benefits are to be paid.

Given that state and local taxes eat up another 10-15%, then that would mean Americans would have to accept Swedish-style tax rates of 50% or more. That seems unlikely. And at least the Swedes have universal healthcare and free higher education--two huge benefits which aren't even in the U.S. entitlement picture.

I then posited a "class war" between the approximately 30 million government and related agencies (school districts, municipal water districts, transit agencies, etc.) retirees/employees and the 100 million taxpayers who are largely dependent on private retirement funds (401K and IRAs). The taxpayers are facing huge tax increases to fund extremely rich (compared to a meagre IRA-and-Social Security retirement) pensions and healthcare benefits for public employees.

Public pensions often outstrip the wages paid to the employees; in many cases, military and other government pensioners have worked a second career and are now "double-dippers" at the public trough--there are even "triple-dippers" pulling in three pensions.

As the financial meltdown destroys stocks and bonds, the pension funds which are supposed to fund these rich retirements will be decimated. This is how the war will begin: the public employees will demand the taxpayers foot the bill, as "we were promised these benefits."
Well, guess what--employees of Enron were "promised" this and that, too--but when your employer goes belly up, all the promises go by the wayside.

The political battles UKC alludes to are entirely predictable: as public unions hold huge sway over politicians, the politicians will naturally strip their budgets to placate the unions. As I have covered here before, the rising costs of municipal healthcare and pension benefits are already pushing municipal and agency budgets into the red:

What's Different Now (July 12, 2007)

In 2005, $15 million of Berkeley’s $115 million general fund will pay for contributions to the California Public Employees System (PERS). Last year, the city spent $8 million on retirement benefits. The year before, when the state Legislature passed the bill that allowed Berkeley to improve the pension benefits, the city spent only $2.8 million."

City employees retire with 84% of their highest salary--about $85,000 (plus generous benefits) for higher ranks of police and fire department employees.
How many private-sector retirees are pulling down over $100,000 a year in pension and healthcare benefits? Very very few. Yet it is the private-sector taxpayers whose "benefits"--in the form of serviceable streets, open libraries, etc., which will be stripped in order to fund the promised pensions.

It doesn't take much of a crystal ball to see the budget crisis facing suburban cities which depend on a growing housing market for revenues.

According to the The Atlantic article cited above:
Nelson forecasts a likely surplus of 22 million large-lot homes (houses built on a sixth of an acre or more) by 2025—that’s roughly 40 percent of the large-lot homes in existence today. 22 million empty McMansions aren't going to generate much tax revenue."

The near-bankruptcy of Vallejo, Calif. offers a snapshot of the future: California Suburb Vallejo Faces Bankruptcy.

The play will unfold in predictable fashion: the municipal unions and city leaders will hash out some modest cuts and announce "problem solved," and then a few months later the city will announce--surprise--revenues have declined even more than expected. Another round of negotiations begins, only this time the unions are not so generous: they demand cuts in basic services and current staffing to pay for pensions and retiree benefits.

The city either caves in and closes fire stations and libraries and cuts staff in every department, eliciting howls of protest from disgruntled citizens, or it declares bankruptcy. The union lawyers jump into the bankruptcy fray, claiming the city is going BK just to evade its "responsibilities." (Never mind the taxpayers--they are mere sheep being led to the slaughter.)

Beneath all the political wrangling the fact remains that the city cannot afford the pensions which were promised at the height of the dot-com boom.

As wage earners become unemployed, tax revenues will continue to decline, and the vise will only tighten around city, county and agency budgets. Any politician who publicly demands the pension and benefit packages be re-neotiated in light of reality will face unions willing to spend their last dime to defeat such backsliding. The distracted, harried taxpayer/citizen will not contribute to the candidate who might actually seek a truly affordable budget, and so the "compromisers" will win--those with union backing who will hope to trim here and there but retain the pensions and benefits promises which are crushing the city budget in a vice of rising retirement costs and shrinking revenues.

This will go on until someone forces the city into bankruptcy. Then the issues will be hashed out in court, and the citizenry can only hope the judge will show more long-term wisdom than the leaders they elected.

And if the municipal bond market dries up, then cities will not be able to fund infrastruture repairs by selling bonds--which by the way, costs the taxpayers double or triple when interest and other costs are included.

Will the bankruptcy judge look at the potholed streets and decrepit public works before deciding how to handle the pension and benefits of city retirees? Will the judge be aware the municipal bond spigot has been turned off? The citizenry might well prepare themselves to let him/her know, because in the fight over the remaining public revenue stream, no one else will be interested in anything but their share of the crumbling, shrinking pie.

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