A Novel Budget Deficit Approach From the City of Angels

Includes: CMF, CXA, INY, NYF, PWZ, PZT
by: Jim Delaney

Towards the end of last year the WSJ published the results of a study conducted by the Gallup Organization and Healthways, a disease management company, which ranked each of the 50 United States with regard to the resident’s satisfaction. The survey was not a one time review but the initial findings of a poll that will query 1,000 Americans every day on areas relating to their health and happiness for the next 25 years.

Louisiana came in first but considering that ‘Aints fans were being transformed into Saints fans on the New Orleans team’s run to a championship season as well as the state having survived the latest hurricane season without catastrophic consequences, it stands to reason.

New York came in dead last which makes one question whether the joy of seeing Wall St. demonized on T.V. was actually better than suffering the real-life affects of having tens of thousands of high earners lose their jobs and the tax base and spending on goods and services that goes along with it.

Some of the monies from the $787BN stimulus package were directed at the states which might have lifted the general mood across the board but it seems that those funds could have created problems of their own.

In many states lawmakers used the stimulus to fund added health care benefits and child care programs which had no economic payback and as such are now creating bigger deficits. The environmental grants given as part of the stimulus had “matching funds” clauses which necessitated spending of money by the states (that they didn’t have) to receive the grants and the funds slated for construction came with Davis-Bacon wage requirements which required the use of unionized workers, thus raising the costs of those projects. Lastly, Congress imposed “maintenance of effort” spending requirements that prevent spending cuts on 15 different programs from road-building to welfare if the state took even minimal stimulus money.

As daunting as the state-level fiscal fiasco created by the American Recovery and Reinvestment Act would appear, it is nothing when compared to the looming crisis caused by the under-funded pension liabilities of the states and cities for the 23MM active and retired public employees.

One major cause of the problem is that many of the pensions are “defined-benefit” plans which are required to pay calculated benefits regardless of how the assets backing the plan perform.

This might not be as big a problem as it is if the benefits were calculated over the person’s entire career but most public employees are receiving benefits equal to somewhere between 75%-90% of their peak earning years. Additionally, a practice known as “spiking” (working astronomical amounts of overtime and including all unused sick and vacation days in the last year of employment) artificially raises the level off of which the aforementioned 75%-90% is calculated. Nice for the individual retiree? Yes. Sustainable for the states on a long term basis? No.

Since, unlike Uncle Sam, the states are required to balance their budgets, cuts in services are being incurred to slow the outflow. Four-day school weeks, smaller police forces and fire departments are not only being discussed as options but are the types of actions being taken.

With U.S. academic scores in science and math already below that of many other nations, it would seem that reducing the amount of time our children spend in schools will not do much except put America’s youth further behind the global curve. For those that argue the number of hours will remain the same, it is just the number of days that is being reduced; I would ask you to judge your own effectiveness during the last 3 hours of a 12 hour work day. As for reductions in police protection and fire safety, there is not much need to state the obvious.

There is a ray of hope amid all this gloom however and fittingly it comes from the City of Angels. L.A. is currently facing a $200MM budget gap, caused in large part by the issues outlined above. The city has taken a novel approach to solving its budget crisis however and has cut the amount of tax Internet companies have to pay. City officials believe the tax break will be a key to L.A.’s turnaround. “If we didn’t roll that [tax] back, there was a real chance many of them would leave,” was the feeling of Austin Butler, L.A.’s new economic chief. He added, “They’re high paying businesses and the wages are spent in our city.” A report by the city warned that if the tax cut wasn’t approved “the ongoing revenue loss would likely exceed $3.4MM in future years.”

What’s most telling about this change in mind-set is that it’s not happening in Des Moines, it’s happening in L.A.

CDS levels on California closed last night at 234bps. That is down off the recent high of 334bps on February 2nd of this year but off the 163bps low seen on October 23rd of last year.

New York State’s CDS closed at 175bps last night which is closer to the 231bps high seen on 2/25/2010 than the 84bp level seen a few times during 4Q09.

There is no actively quoted CDS market on Louisiana, Iowa or L.A.