Cities and States Exchange Stimulus For Debt

What we all knew was true has now been put into a graph.  John Taylor and John Cogan wrote an article that outlines the ineffectiveness of the stimulus money that was provided to cities and states.  Their finding was that there was no stimulus effect, meaning a sudden creation of more economic activity, because cities and states did not embark on greater spending at all.  Instead, these entities replaced what would have been their own borrowing (issuing bonds) with grants from the US government.  So in effect, we nationalized the spending of cities and states, putting the cost on all taxpayers instead of assigning the cost of each city and state to its own constituents.

The interesting part to me is not the simple relationship on the face of the article, but the greater questions of why this happened and what lies ahead.  The municipal bond market froze just like other credit markets in late 2008 and early 2009.  When cities and states were reeling from dramatic revenue declines, they were also unable to tap credit markets for much-needed cash.  The US government came through with two programs – the stimulus and the Build America Bond program.  The stimulus is straightforward -we gave them money.  The Build America Bond (BAB) program allowed cities and states to get a 35% subsidy on the interest cost of bonds issued for infrastructure.  The subsidy is paid by the US govt, but it also makes the bonds taxable.  The BAB program allowed a lot of issuers (CA, IL, etc.) to issue bonds that they would not otherwise have been able to issue, as credit markets deem them too risky.  Which leads to today.

The BAB program is set to expire at month’s end.  There is a rash of muni issuance right now, trying to get in under the wire.  Cities and states have seen some increase in their revenue over last year, but nothing like the recent high water marks, and many (CA, IL, again) are ridiculously underwater in their current budget. 

My point is, all we have done is kick the can down the road, hoping the situation would “resolve itself.”  It has not.  Nationalizing a problem does not, in and of itself, fix a problem.  When do we nationalize our national problems?  Maybe Germany would like to guarantee US bonds.

Read more at H. S. Dent