Just the Beginning: Expect Exodus

Admittedly, the food sparked riots in the Middle East offer riveting theater and have serious economic implications.  However, it is too early for me to properly assess the damage, and it is a sideshow compared to far greater economic impact symbolized by the mass demonstrations in Wisconsin.

First, let’s quickly clear up some easy issues.  If not unconstitutional, it is certainly immoral to enact a law denying anyone the right to assemble with like minded people to appoint an agent to negotiate on their behalf – a/k/a collective bargaining.  In addition, there is nothing wrong with private parties negotiating a closed shop.  However, it would be wrong for a closed shop to exist in a government setting.

The attempt by the righties to strip the public unions of collective bargaining is why I get the dry heaves every time a libertarian allows himself to be labeled a conservative.  Milton Friedman let it slide all the time.  Conservatives do not believe in limited government or free markets.  Wisconsin is just one more shameless episode proving the point.

The real story for the week, especially for those of you who own your own home, is that Wisconsin is yet another signpost on the road to fiscal abyss for the majority of state and local governments.  Wisconsin faces a $3.6 billion deficit for the coming year, and much greater future deficits turbocharged by unfunded pension liabilities.  Nationally, the estimated combined state and local government deficit for next year alone is over $125 billion.  Even that number rests on the dubious assumption that the economy will show relatively robust growth.   The important principle for you to understand and apply is that some localities will get crushed and others may even thrive.  Here, we will try to sketch out a road map for you.

It stands to reason that the states and localities with the biggest fiscal holes visible today are most likely to collapse into the fiscal vortex.  Right now Illinois heads the list with the largest deficits and unfunded liabilities relative to the size of its economy.  Chicago is in a pickle as well.  Providence, Rhode Island is already insolvent, and resorting to wildly desperate measures like preemptively firing all of it public school teachers.  There are many cities and towns that are in this club that do not make the headlines.

The next question then, is how well you think the politicians will handle the situation, and whether the voting public will force fiscal rectitude upon those politicians.  The precedence of the historical record is grim.  This means that anyone living in a financially stressed state or locality will inexorably face higher taxes and declining services to the point of excruciating pain.  This is where accepted credit analysis of state and local debt breaks down.  Credit analysts crunch numbers.  Like modern macro economists, they ignore people.  Even worse, they always extrapolate recent history.  Both mistakes are deadly to your financial well being if you follow the rosy conclusions reached by those that make them.

The only people who saw the financial crisis coming in advance were those who did not extrapolate the post WWII economy into the future.  They realized that just because the economy behaved a certain way for sixty years did not mean that it must always follow the same script.  These same people will tell you that you must continue to ignore all post great depression patterns.  We face something very different and far worse.

This means that the assumptions made by the number crunching municipal credit analysts are wrong, and their rosy conclusions are wrong.  Defaults will not be limited to smaller cities and towns plus a few revenue bonds (e.g. hospitals).  There is a high probability that even some states will have to throw in the towel.  Of course, if you think we are currently in a self-sustaining economic recovery similar to, though weaker than, past recoveries, then you can stop right here.  If you think that the bottom has not been reached (as outlined in many of my past posts), then please continue as we analyze how the people factor affects our results.

The biggest difference this time around in how state and local debt will fare centers on the very new and different actions that will be taken by large numbers of people in response to deteriorating services and sharply higher taxes.  People will pack up and leave in numbers never seen before.  The first to leave will be smaller businesses that will close and relocate to more hospitable places.  Next will be the lower income, but above poverty line renters who have nothing holding them back.  Finally will be hordes of underwater homeowners fleeing, in many cases with little more than what they can pack into their cars.  Throughout, as taxes rise, the very rich will seek greener locations as well.

The impact of large numbers of people fleeing the localities in worst shape is unlike anything the number crunchers plug into their algorithms.  A close approximation to the devastation we will witness is Detroit.  Keep in mind that the withering of Detroit occurred over fifty years.  What happens when a city loses half its population in just a few years?  Consider the effects of ten million inhabitants of California heading east in just a few years.  The number crunchers place absolute faith in the taxing authority of state and local governments to see them through any crisis.  But who will be left to tax?

This mass exodus will emanate from those states and cities with the highest taxes and biggest budget holes.  The usual suspects start with Illinois, California, New Jersey, New York and Michigan.  Once the exodus reaches a critical mass, then you will have hundreds of municipal defaults for many hundred of $billions.  You do not want to be one of those forlorn souls left behind.  Oddly enough, of the states listed above, it is not New Jersey led by republican icon Chris Christie that has the best chance of beating the long odds, but New York.  The main reason is that Andrew Cuomo has strong liberal democrat credentials that will give him cover to make the necessary cuts with less criticism – akin to arch anti-commie tricky Dicky Nixon opening up China.  Even so, I would still bet against him as well.

My best guess for states that will receive disproportionate shares of émigrés starts with Arizona.  It happened ten years ago when California imploded over the Enron utility deregulation fiasco as many people headed due east landed in Phoenix goosing that city’s growth.  Notwithstanding its current difficulties, Nevada is likely to benefit as well.  The surest bets appear to be Oklahoma (oil), Kansas, Nebraska and Iowa.  Farming will be an excellent business during these bad times.

The most valuable advice I can offer is for each of you to get very active in local politics.  Only those places that get serious about their finances now will have any chance later.  The second piece of advice is that if you may need to sell your home, do it now!  Third, if you are underwater, see an attorney with real expertise in the relevant law and learn all you can about your options and their consequences.

All the best to you all,

Stephen Reiss
[email protected]

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