Sat04192014

Last updateTue, 04 Nov 2014 9pm

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Local governments and the recession: some twists, some turns, some IOUs

During a recession, the Federal Government has one big advantage over everyone else. It can run a deficit and continue to borrow. In a sense, as some like to say, it can just keep printing money. However, other governments, such as states, counties, towns and cities, don’t have this option. Though some can run a deficit for a little while, in the end, they all have to come up with some way to balance the books.
Though revenue for local governments often fluctuates, sometimes dramatically, they rarely find themselves looking at the possibility of default. Usually, through belt tightening, higher taxes and borrowing, they can get through a tough spot. However, this year is putting the soundness of many state and local governments to the test. Some are getting by and others aren’t doing well at all.

The U.S. economy is facing what may be its worse downturn since the Great Depression. This has meant that every local government in our region, whether it’s King George, Stafford, or Spotsylvania is dealing with dramatically reduced revenues. Property values are down sharply, homes have been foreclosed — which means no one is paying taxes on the property — and sales taxes are off. This has meant cutbacks in government services and in some cases furloughs and layoffs. Even the state government hasn’t been spared. Virginia is looking at a substantial fall in revenues, perhaps as much as 10 percent, that has already meant severe reductions in state services with more cutbacks likely to come. Schools aren’t getting the money they hoped, DMV offices are closing or shortening their hours, and even rest stops on the interstates have been closed.

However, none of our local governments, and certainly not the state, which is constitutionally obliged to balance its budget, is likely to go under. Things just aren’t anywhere near that bad. But, that hasn’t always been the case. During the Great Depression more than 3,000 American cities and counties defaulted on their debt obligations. Some towns continued to operate, even in default, while others went out of existence altogether. It was a grim time to be in local government.
During the depression era, King George County Schools and Stafford County Schools were administered by the same school board. As the economy started to contract, the board, facing significantly lower revenues, was forced to cut teacher salaries to below $600 a year. The school system continued to function, as did the rest of local government, but it only just got by.
Today’s recession, while severe isn’t nearly that bad. Several large cities are in financial trouble, but none, at least not at the moment, is looking at default. However, there is one notable exception and that’s California. The most heavily populated state in the nation, and arguably the richest, is nearing a financial meltdown. It could even be said that it’s already gotten to that point. California has had it share of financial crises. But this year, thanks to the recession, facing a dramatic downturn in revenue, the state assembly hasn’t been able to come to agreement on a new budget.  
It comes down to this. The Republicans in the California Assembly, joined by the governor, insist that the way to balance the budget is through cutbacks, and in particular, reductions in the state’s large social welfare programs. The Democrats on the other hand are balking at this and want higher taxes. Unfortunately, or fortunately, depending on your point of view, they can’t get these higher taxes unless they have a two-thirds majority. And this means they need the GOP to go along with them. So far, neither side is budging.
In the meantime, California, in one of the most comic twists of this recession, is issuing IOUs. On their first day of writing these bizarre financial instruments, they printed 33,000 and will likely in the next week or two have written a $1 billion worth of IOUs. The state, of course, still has some cash, but that’s limited by the state constitution to servicing the state’s bonds and funding education. As for the rest of their obligations, including tax refunds, the IOUs will have to do.
It’s whacky, but it doesn’t stop there. California, reasonably enough, is paying interest on their IOUs and it seems they’re a pretty good investment.  The current annualized rate on a California IOU is roughly 3.75 percent. That’s a rate that’s hard to get anywhere else. But just to prolong this story a little bit further, the U.S. Securities and Exchange Commission, the same folks who presided over our financial meltdown, have said that the IOUs are investment instruments and as such will have to be regulated.
California, hopefully, will resolve its crisis. If it doesn’t, things could be bad for the citizens of the Gold State. But even that has a bright side to it. Maybe it will take a meltdown, prompted by this recession, for the state to come to grips with the dysfunctional political and financial system that helped get them into this mess.
Meanwhile, home in Virginia, where I often grimace at the politics and the impasses in Richmond there are times, and this is one of them, when the Commonwealth seems like a pretty nice place to be after all. At the very least, when I get my income tax refund I won’t get an IOU.
You  may reach David Kerr at kerr @journalpress.com

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