A Telling Sign of Things to Come

The Labor Department reported last Friday that 103,000 jobs were added in September.  Considering the lethargic state of the economy, this number could have been much worse.  Nonetheless, a quick scratch below the surface reveals the headline jobs number wasn’t quite what it first appeared.

In particular, the jobs number included the return of 45,000 communications workers that had been on strike.  If you exclude them from the jobs report, employment increased by a measly 58,000.  Still, even the official 103,000 jobs count was not enough to lower the unemployment rate from 9.1 percent.  There were also several other substandard statistics buried below the headlines in the September labor report.

For example, the average duration of unemployment marked a record high of 40.5 weeks.  In addition, close to 45 percent of the 14 million unemployed had been out of work for greater than six months – up from 42.9 percent in August.  Yet even worse, when including people who want to work, but have given up looking for a job, and people who work part time, but want to work full time, the unemployment rate increased to 16.5 percent.

Even to the most optimist observer, the jobs market appears to be stuck in first gear.  While the economy, as measured in GDP, is not technically declining, its growth is not sufficient to help lower the debt burden.  People are largely aware of the problems this is causing at the federal level.  But the next debt crisis, the crisis that’s already happening, will not be at the federal level…it will be at the state and local level.

State and local governments have grossly over committed to their worker pension programs.  As tax receipts wane, the stark reality that pension payments or services – or both – will have to give is becoming painfully evident. Here, we’ll pause, to look to our home State of California for instruction…

California’s Financial Sickness

California, no doubt, is a wacky and zany place. It’s the ‘land of fruits and nuts.’  These days California’s finances are plagued by the same affliction that’s plaguing many states across the union…only here it’s magnified in size and absurdity.  Namely, a massive budget shortfall and a shortfall of political will to do anything about it.

Michael Lewis may be the most well-known financial journalist writing today.  The November issue of Vanity Fair published an article by Lewis titled, California and Bust, which covered California’s financial sickness and its abundance of overpaid government workers.

While researching the article, Lewis spent some time in the Golden State becoming acquainted with the California Dream of wanting lots of services but not wanting to pay for them.  As part of Lewis’ investigation he spent a morning with former Governor Arnold Schwarzenegger, and Schwarzenegger’s former economic adviser, David Crane, riding bicycles in Santa Monica.

According to Crane, “This year the state will directly spend $32 billion on employee pay and benefits, up 65 percent over the past 10 years.  Compare that to state spending on higher education [down 5 percent], health and human services [up just 5 percent], and parks and recreation [flat], all crowded out in large part by fast-rising employment costs.”

But that’s nothing…

A Telling Sign of Things to Come

Lewis discovered that at the city level the problems are much worse.  The City of Vallejo, for instance, offers a telling sign of things to come.

In 2008, when Vallejo declared bankruptcy, 80 percent of its budget went to the paychecks and benefits of public safety workers.  In August of 2011, as part of its bankruptcy plan, “Vallejo’s creditors ended up with 5 cents on the dollar, public employees with something like 20 and 30 cents on the dollar.”

Today the city operates with just over half the firefighters it did less than three years ago.  “Weeds surround abandoned businesses, and all traffic lights are set to permanently blink, which is a formality, as there are no longer any cops to police the streets.”

Clearly, this is a horrible situation. Moreover, it’s a story that will be told across the country over and over again.  The housing boom, blown full of hot air by artificially low interest rates courtesy of the Federal Reserve, created a magnificent public financing distortion.  As housing values doubled, property tax receipts overfilled local coffers like Mississippi flood waters.

Local leaders, unfortunately, misunderstood what was going on.  They took the false signal of their one off revenue increase and projected it out into the future.  These budget projections were then used as the basis for negotiating city employee benefits, pensions, and budgeting capital improvement projects.  The painful fact is there’s no way these promises and contracts can be kept in today’s economy.

In hindsight it is so obvious.  Now that the rug has been pulled out from under city finances it is evident that the decisions made during the housing bubble were utterly delusional.  Cities, and there residents, must now live with the consequences.

Promises will be broken, services will be cut, and in some place the trash will pile up in the streets as a ghastly monument to the false mirage of unending prosperity that came before.

Sincerely,

MN Gordon
for Economic Prism

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