Cities and towns need to start helping themselves.

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Cities and towns need to start helping themselves.

Wracked by foreclosures and by the collapsing muncipal bond market, cities and towns should start planning immediately. (2-Mar-2008)

Summary Cities and towns are being hit from all directions. Foreclosures are surging, increasing expenses and reducing revenues. And the municipal bond market has all but collapsed. Towns will have little choice but to slash budgets sharply. But they can help themselves by setting up volunteer programs to help homeowners, clean up blighted neighborhoods, and prevent crime. Unfortunately, so far, most city and town officials are simply living in a fantasy where the real estate bubble starts reflating, something that won’t happen.

Contents – This page
The increasing foreclosure problem
The collapse of the municipal bond market
Why are cities and towns reluctant to face this?
How cities and towns can help themselves

Cities and towns need to start planning: The leaking housing bubble has already done a great deal of damage, and is getting worse. What will we do when the worst comes?

Unfortunately, many municipal officials around the country are living in a Charlie Brown dreamland, where no problem is so big that it can’t be run away from. They’re ignoring what’s going on right before their eyes, and acting as if the Hand of God (or, even less likely, the Hand of the Federal Government) were going to reach down and reflate the housing bubble.

On this web site, I frequently post this advice: You can’t stop what’s coming, but you can prepare for it. Treasure the time you have left, and use it to prepare yourself, your family, your community and your nation.

We’ve focused a great deal on how to prepare yourself and your family, but how can your community prepare? The purpose of this article is to answer that question, and to encourage cities and towns to start preparing now.

The increasing foreclosure problem

There’s certainly a desperate need to prepare. Foreclosures are surging across the country, because so many people are “under water” in their homes.

What this means is that, thanks to falling home prices, homeowners increasingly owe more on their mortgages than their homes are worth. As ARM (adjustable rate mortgage) “teaser” rates reset — and most resets are due in the next year — homeowners are faced with double or triple their original monthly mortgage payments.

Even homeowners who theoretically could afford to meet their mortgage payments often see no point to doing so, and simply walk away. According to CNN Money:

“Homeowners are abandoning their homes and, more importantly, their mortgages, rather than trying to keep up with rising payments on deteriorating assets. So many people are handing their keys back to lenders that a new term has been coined for it: jingle mail. …Beyond anecdotes, some statistics indicate that hard-pressed owners are deliberately courting foreclosure. An analysis by the consumer credit rating agency Experian last spring found that many borrowers were choosing to pay off credit card and other consumer debt before making mortgage payments. They were electing to put their mortgage at risk rather than their credit cards or auto loans.”

And it’s going to get worse — much worse. Municipal officials around the country are sticking their heads in the sands about this, desperately clinging to the belief that housing bubble is going to start inflating again. That’s absolutely not going to happen.

In fact, a study by Merrill Lynch says that home prices are going to continue to fall — by 25% through 2009. Thus, the total value of the nation’s housing will fall from $20 trillion to $15 trillion.


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The worst is yet to come. The percentage of homeowners who have zero or negative equity in their homes is expected to continue to rise over the next 18 months. (Source: NY Times)

This means that the worst is yet to come, according to a study reported in New York Times:

“Not since the Depression has a larger share of Americans owed more on their homes than they are worth. With the collapse of the housing boom, nearly 8.8 million homeowners, or 10.3 percent of the total, are underwater. That is more than double the percentage just a year ago, according to a new estimate of the damage by Moody’s Economy.com. …Many owners are only gradually becoming aware that their homes would sell for less than the debt against them — a phenomenon, said Richard T. Curtin, director of the Reuters/University of Michigan Surveys of Consumers, that is “beginning to weigh on people, making them uncertain and nervous about the future.” …

“People can’t believe this is happening to them,” said Robert Moulton, president of the Americana Mortgage Group in Manhasset, N.Y. …

[Bank of America] has warned that tightening credit conditions were leading to “escalating levels of delinquency and default among borrowers” and “an unprecedented number” of homes that would enter foreclosure.”

Municipal officials around the country have got to stop living in a fantasyland where they talk about next year’s budget as if it were going to stay constant or increase.

The surging foreclosure problem is going to cut deeply into funds available to municipalities:

  • Property tax collections will fall sharply, because home prices will fall and fewer buildings will pay taxes.
  • Neighborhoods with multiple vacant homes become blighted, causing a further downward spiral in property values, and additional service costs.
  • Homeless people often turn into unemployed vagrants, sometimes turning to crime out of desperation. This requires additional police support.
  • Even renters can suddenly become homeless — when the landlord loses the apartment building through foreclosure.
  • Vacant buildings are targets of crime. Thieves and scavengers steal fixtures, metal pipes, copper wiring, aluminum sidings and anything else of value from empty homes, leaving empty shells.
  • In many neighborhoods, vacant buildings must be demolished, which is expensive. Cleveland Ohio, whose demolition budget was $6 million in 2007, now must budget $100 million to demolish 10,000 abandoned buildings.

All of these factors mean that the money available for teachers, schools, police, firefighters and municipal programs must be cut drastically.

I’m constantly reminded these days of a remark by one of my school teachers in the 1950s. Her name was Miss Shepherd, and she had a wooden leg — I assume she lost her leg in the war, but I don’t know. Anyway, one day out of the blue she said, “People think that if you have a job as a schoolteacher, then your job is safe, because they always need schoolteachers. But that isn’t what happened in the 1930s. They would put two or three classes together in a single room, and replace three teachers with just one teacher.” That’s all I remember, except that she was very emotional when she said it — a combination of anger and sadness.

That’s what almost every municipality is going to be looking forward to for the next few years. The earlier that you start preparing, the better off you’ll be.

The collapse of the municipal bond market

In bubble times, and even in normal times, cities and towns get through rough times by borrowing money. And they get a pretty good deal, because they have to pay very low interest rates.

Muncipalities borrow money by selling tax-free muncipal bonds. Investors who purchase municipal bonds don’t have to pay taxes on the earned interest, and this is very appealing to wealthy investors in high tax brackets. Furthermore, municipal bonds are considered extremely safe, because muncipalities can pay them off from real estate taxes if necessary. Because of these two advantages, municipal bonds typically have always been considered very safe, and pay very low yields (interest rates). This was a big advantage to municipalities, who end up borrowing money almost for free.

Contents – This page
The increasing foreclosure problem
The collapse of the municipal bond market
Why are cities and towns reluctant to face this?
How cities and towns can help themselves

Unfortunately, most municipalities weren’t satisfied with these advantages; they wanted more. And so, just as mortgage loans have been “securitized” into CDOs, municipal bonds have been “securitized.”

(For those interested in the math behind the creation of CDOs from mortgage-backed securities, and how they get AAA ratings from “monoline” bond insurers, see “A primer on financial engineering and structured finance.”)

Not only that, but additional structured finance techniques were used. They became “auction rate securities” (ARSs) which I described in “Wealthy investors in auction rate securities can’t get their money out.” The ARS concept is to take advantage of short-term yields, which are usually lower than long-term rates. By running an auction every couple of weeks, the yields are always short-term, even though the underlying bonds are long-term.

That works great as long as the auctions work great. But thanks to the credit crunch that began in August, 2007, investors stopped bidding at these auctions. As a result, municipalities can no longer sell bonds through ARSs.

Financial instruments today are intricately interlocked with one another in ways that no one understands. A short time ago, a ratings agency lowered the debt rating of some of the assets owned by Ambac, the bond insurer. The triggered a lower rating on some state government bonds insured by Ambac, which frightened off investors in these and other muncipal bonds.

And so we have a mess. Investors who own municipal bond based ARSs can’t get rid of them, and muncipalities can’t sell any more of them.

The result is that municipal bond market today has effectively collapsed.

Some analysts have been ridiculing this situation, pointing out that muncipal bonds have always been extremely safe.

That may have been true in the bubble days, but it’s not true any more. Governor Arnold Schwarzenegger declared last month that the entire state of California is in a state of fiscal emergency.

The city of Vallejo, located just outside of San Francisco, will not be able to meet payrolls on March 31, and is close to declaring bankruptcy. Negotiations are continuing, and depend on whether labor unions will agree to forego wage increases. According to Bloomberg,

“Clark Stamper, who oversees $600 million of municipal bonds at Stamper Capital & Investments, including Vallejo debt, said a bankruptcy filing could encourage other California communities to consider the step should the city persuade a judge to reopen labor agreements.”What happens in Vallejo is going to be the model for what happens across the state,” Stamper said yesterday. “It will have a big impact.”

It will undoubtedly also be a model across the country. And so, despite what the analysts and pundits say, municipal bond really aren’t particularly safe — not any more.

The collapse of the municipal bond market is having a domino effect in the world of hedge funds. Many large hedge funds have been investing in municipal bonds, and are getting into trouble, thanks to the same problem with auction-rate securities.

In fact, these hedge funds started to get into trouble in August, when the credit crunch began, according to an article that appeared at the time.

By now, these hedge funds have lost enough money that they’ve used up all their spare cash. They’re now being forced to sell their municipal bonds at fire sale prices, just to get some cash. This fire sale is flooding the market with municipal bonds, pushing their prices down lower and their yields higher. (The lower the price on a bond, the higher its yield (interest rate) is.)

So municipal bonds often can’t be sold at all these days or, if they can, it’s only at very high yields that would require the municipality to pay exhorbitant interest rates for years.

Why are cities and towns reluctant to face this?

Perhaps it’s natural for city and town officials to play ostrich and pretend that this problem doesn’t exist. After all, it’s going to have horrible consequences, and nobody wants to think about them until forced to.

Contents – This page
The increasing foreclosure problem
The collapse of the municipal bond market
Why are cities and towns reluctant to face this?
How cities and towns can help themselves

Even worse, some town officials may be under water in their homes and may be facing foreclosures themselves. They may be afraid that dealing with the town’s problems will lead to their own humiliation. This is no reason why a town should delay planning.

The problem is that this problem will only get worse. A town that starts planning early can at least save money by not making unnecessary expenditures. There’s no question that a town whose officials start thinking about this problem early will have more options available than a town that waits until they’re forced to act.

Some people may believe that facing this problem will make their town look bad. Actually, I believe that the opposite is true — a town that starts planning can turn it into a public relations positive, and may thus get some benefit from it.

There are darker reasons why some officials may be unwilling to deal with this problem.

Some municipalities may be in trouble because the town officials invested in CDOs or other structured investments that are now near-worthless, and they’re afraid to let this information become public.

Jefferson County, Alabama, is being particularly hard hit. The county commissioners issued $3.2 billion in municipal bonds for the sewer system in the form of ARSs, and now the auctions have failed. The result? The County is now facing hundreds of millions of dollars in additional interest payments.

Even worse, some town officials may have gone even farther.

John Kenneth Galbraith, in his study of the 1929 crash, found that many desperate people resorted to embezzlement to try to save themselves financially. It’s possible that some town officials may have embezzled from someone, perhaps even the town, and are afraid the embezzlement might be exposed.

These problems are all going to be exposed anyway. In good times (i.e., bubble times), when everyone is making money, then problems are ignored, and even embezzlement is ignored. When times turn bad, then everyone becomes an auditor, and every account is examined with a fine tooth comb. We’re going to see a substantial spike in these kinds of crimes, just as happened in 1930.

These are all good reasons to start planning for this fiscal problem. At the very least, every city and town should “lock down” all its funds right away, to make sure that they remain safe as the situation worsens.

How cities and towns can help themselves

Here’s an example: Students from the Flint, Mich., campus of University of Michigan are volunteering to clean up foreclosed properties, performing such chores as cleaning debris, tearing up old carpets, and replacing boarded up windows, so that the house can be made available for another family. Some students were part of a pilot series of classes at the university aimed to get first-time college freshmen more involved with the surrounding community. Others were just volunteers.

Flint is particularly hard-hit, because of the loss of jobs at General Motors, but there’s no reason why any town can’t proactively set up a program like this, before it becomes absolutely necessary.

Many of these programs could make sense even in “normal” times; but they are essential in these increasingly difficult times.

Here are some examples:

  • Local government officials and community groups can start working with banks and lending organizations to help delinquent homeowners. Lending organizations are already initiating these kinds of efforts. The situation is that a foreclosure is hugely expensive for a bank, and they’d like to work with a delinquent homeowner to work something out, but delinquent homeowners are afraid to answer the phone or respond when the bank calls. Community groups can work with both groups, and perhaps help a lot of people who might otherwise become homeless.
  • In the midwest, which has been hard hit already, many cities and towns are joining together to form land banks to buy distressed properties and either demolish them or repair and sell them. Buffalo, N.Y., brings property owners and lenders together in court on monthly “Bank Days” to find solutions for cleaning up vacant homes. Tax delinquent properties, which would normally be demolished, are made available for development.
  • Town officials can educate local homeowners to beware of foreclosure scams — people who trick homeowners into signing away their homes and getting nothing in return.
  • Officials can work with local judges to bring speedy results for properties that aren’t being kept up.
  • Keeping neighborhoods from becoming blighted is essential, and requires as early a start as possible. Volunteers can be drawn from many sources — high schools, colleges, businesses, community groups, Rotary clubs, and so forth. These volunteers can perform a variety of tasks, such as cleaning up foreclosed properties.
  • Another source of volunteers is unemployed people. With real estate construction down, building contractors are particularly hard hit. Some of these unemployed contractors may be persuaded to do construction work on foreclosed properties for no salary, or for expenses only. The benefit to them is that they would be keeping their skills up, maintaining contacts for when jobs become available again, and generally spending time better than sitting in front of a TV.
  • Teams of volunteers could be assigned to hard-hit neighborhoods. Studies have shown that even a few broken windows in a neighborhood can have a domino effect in causing the entire neighborhood to deteriorate.
  • Such a team could consist of volunteers who maintain foreclosed problems, and other volunteers who maintain a “neighborhood watch,” keeping out vagrants and scavengers who might steal fixtures and plumbing from foreclosed properties.
  • Alternatively, groups of homeless families could be permitted to occupy foreclosed properties rent-free, in return for taking ordinary care of the property.
  • Knowledgeable people could volunteer to give courses to help unemployed people to develop new skills. In some geographical areas, these skills might include growing vegetable gardens in one’s back yard.
  • City officials should lock down all city finances. As people become more desperate, embezzlement becomes more tempting.
  • City officials can coordinate with charitable groups to provide soup kitchens and other kinds of support.
  • Infectious disease may be a major concern, and a major bird flu pandemic is still a very viable possibility. City officials can work with state and federal agencies to prepare plans for dealing with infectious disease.
  • City officials can prepare contingency plans, based on different assumptions for how much the budget will have to be cut. Contingency plans for budget cuts of 10%, 20%, 30%, 40% and 50% would be prudent.
  • Since layoffs will be required, some kind of lottery system could be set up in advance to determine who will be laid off. If people have some idea that they might be laid off, they may decide to move in with family members in another city.
Contents – This page
The increasing foreclosure problem
The collapse of the municipal bond market
Why are cities and towns reluctant to face this?
How cities and towns can help themselves

These are just ideas that any city or town might consider.

It’s worth pointing out that most of these ideas cost little or no money, but can have ENORMOUS impact in making lives easier for the people of the city or town when the worst comes. It won’t be possible to help everyone, but these plans could help a significant number of people who would otherwise have nowhere to turn.

The most difficult problem will be getting people to cooperate in planning, or even to thinking about this situation.

Unfortunately, there’s very little sense of community these days, much less so than, say, ten years ago. “Community” is nice, but there’s little interest in it these days. Everybody’s out for himself, even at the expense of other people. That’s why the coming financial crisis.

If people in your community start planning now, before it becomes a full-fledged crisis, then it may be possible to create a cooperative atmosphere that will be to everyone’s benefit.

What I’ve said many times is worth repeating now: Treasure the time that you have left, and use it to prepare yourself, your family, your community and your nation.


Copyright © 2002-2008 by John J. Xenakis.         

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