Are local governments on the brink?


Richard Mattoon of Chicago Fed has this nice short article on state of local governments (municipalities etc). He says there is no doubt  that finances have worsened but they filing for bankruptcy etc are overstated.

There have been very few cases of local government bankruptcies in the past. Even in Great Depression there were just 1.8% of local governments defaulting in 1935. By 1937 most such cases had been resolved with average recovery at 97%.

There is little disagreement that 2011 will be a tough year in local government finance. Minimal growth or outright declines in property tax revenues, reduced assistance from state governments, and requirements to make larger payments to underfunded public pension funds will loom large for many local governments. However, if history is any guide, few local governments will either default on their debt or end up in bankruptcy. The aftermaths of actual local government bankruptcies—such as that of Vallejo, CA, in 2008—suggest that governments are hurt badly when they emerge from bankruptcy, particularly in their ability to issue debt. And so, in all but the most dire cases, local governments under stress are likely to take alternative steps to shore up their fiscal positions.

He reviews the tax inflows. Main item here is property tax. As prices of property have crashed one would assume crash in tax revenues as well. But this is not the case:


While there have been declines in property values, administrative features of property tax systems have muted the effects of these declines into actual tax collections. In some cases, time lags in the property value reassessment cycle prevent home values from reflecting the current market conditions. In other instances, revenue collections are authorized for a set dollar value, and they do not change along with property values. According to the U.S. Census Bureau, property tax revenues made up 72% of all local tax revenues in 2007–08.6 Thus, the relatively stable performance of this tax should be welcome news to local governments

Actually a decline has hapenned in in other real estate related activities:


That said, the revenue performances of some other sources have tended to be less robust. During the real estate boom, local governments feasted on development fees and real estate transfer taxes. Since then, these sources of revenues have largely evaporated. For example, in Chicago, revenues from real estate transfer fees peaked at nearly $250 million in 2006, before falling to less than $70 million in 2009.

There is uncertainty over whether state govts will give aid this year or not. But local govts have some rainy day funds to help them survive in case states cut aid packs. The concern is not debt levels but underfunded pension liabilities. The figures are not known and risks remain.

The author asks why then a concern over local govt finances? There were exits from munis bond funds in Dec-10. The reason was not distress in finances but oversupply of munis bonds for Build America Bonds program:

If the rate of municipal credit defaults has been low in recent years and local governments are not likely to file for bankruptcy, then why did the municipal bond market experience such trouble in late 2010 and early 2011? In December 2010, the municipal bond market took a sudden turn for the worse after nearly two years of strong returns. A sudden net outflow of investor money from municipal bond funds, which led to a spike in bond issuing costs, created a stir about the future health of municipal bonds.

However, factors other than a change in the underlying creditworthiness of municipal bond issuers might explain municipal bonds’ poor performance late last year and early this year. For one, local governments may have simply glutted the market with their new bond products. In particular, they rushed to issue taxable, federally subsidized Build America Bonds (BABs) before the BABs program expired at the end of 2010.

While BABs appeal to a different type of investor than traditional tax-exempt municipal bonds, the sheer size of the BABs offerings may have satisfied investors’ appetite for all municipal bonds late last year and into this year. In addition, the Bush tax cuts were extended in December 2010, making the tax advantages of municipal bonds less important for wealthy investors.


Hmmm..Nice stuff…

One Response to “Are local governments on the brink?”

  1. Are local governments on the brink? « Mostly Economics Says:

    […] post: Are local governments on the brink? « Mostly Economics Tagged with: all-local • bureau • census-bureau • instances • not-change […]

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