William Baldwin created quite a stir in the investment world with his article. What Mr. Baldwin found was that there are eleven States where more people earn a living from the government than work in the private sector. To be clear, most of these people work for the government but a large percentage of them are on welfare receiving support in the form of food stamps, pensions and other government hand outs.
To qualify for this list not only did the State need to have a ratio of more than 1 (government paid / private sector) but they also needed to have large levels of debt, an uncompetitive business environment, weakness in home prices and poor unemployment trends. His concern is that these States are on a Death Spiral as there is no way that this trend can continue so his advice is not to buy a house or a municipal bond in or issued by any of these States.
So let's take a detailed look into this advice and how it may affect these States going forward. As I live in California I will concentrate my thoughts on that State but they should hold water in the others as well.
In order for these States to repair their budgets it is clear that they need to start to drive a surplus. That will be near impossible with a workforce that is overwhelmed by State employees and beneficiaries. In order to drive a surplus you need to bring in more tax revenue than you spend so it is pretty simple, either you raise taxes or cut spending or some combination of the two. So let's look at raising taxes. As you are already uncompetitive compared to the other States there is a high probability that business will move to another more business friendly State. This moves the meter in the wrong direction but as we have seen in California taxes are being raised particularly on the wealthy and those are the people that are creating the jobs. Force them out and things get ugly fast and based on the current round of tax increases I expect there will be decent sized migration out of California and this will have a negative impact on 2013 and beyond.
The next place that you can raise taxes is on consumer items in the form of a sales tax or property taxes. Each of these States has poor housing fundamentals so raising property taxes would hurt that sector even further however it is a way to tax the wealthy over the poor. It seems clear to me that it is just a matter of time before property taxes are increased so if you are considering buying a house and you can only marginally afford the payment I would advise to continue renting as when these taxes are raised this could be the difference between losing or keeping your house. Outside of this an increase in the rate of housing tax would put a lid on the housing price increase and would probably result in more short sales but only time will tell on this score.
Increasing sales tax is also hard to do when there are States that charge no sales tax, but this is possibly the least corrosive of all taxes as these are spread among all consumers including those on welfare. In fact a thought would be to push property taxes down (maybe to zero) and increase sales taxes to cover the loss of revenue. This should have a positive impact on housing prices pushing up demand and creating opportunities and employment but I am sure that this will never happen. Furthermore sales tax moves with inflation and should increase year over year while property prices can move about wildly hurting government budgets just at the time when they need the revenue. In addition property taxes benefit those that live in the same house for decades as their rates stay tied to the purchase price of the house. This skews the burden onto the new home owner who is more often than not the most stretched in terms of making ends meet. Not very equitable.
The next thing that has to happen is that these States need to cut spending and the size of the government sector. I have to believe that there are thousands of workers in the government bureaucracies that are not needed, so cutting the pool of labor should not be that difficult outside of the fact that there will be massive political infighting. If, for example, you ran the State like a private business I would imagine that tens of thousands of jobs would be eradicated. In politics however large bureaucracies bring power so I see little in the way of change here unless the job is made to be unbearable which it is, except for the benefits.
Cutting spending is also not a difficult thing to do in theory, but once again practice is another thing completely. For example cutting retirement benefits is an obvious one. The vast majority if not all businesses gave up providing defined benefit retirement plans years ago. It was simply too much of a burden to bear particularly when life expectancy increases every year. They all switched to defined contribution plans where the onus is transferred to the employee who bears the risk. Once again changing this would solve a lot of these States' budget issues but once again that is political suicide. Until there is a major default by a State this will always be off the table but it is the quickest way to turn all of this around. A side effect (benefit if you will) of this cut would be that States would struggle to find anyone who would sign up for the work. This would actually be good as it would force the government to become more efficient and would reduce the number of workers - a double whammy!
So looking at the investments it is hard to think that renting is better than owning, particularly if you can afford it. You do get the tax benefits and pride of ownership and even if the tax rates are raised, while there would put a lid put on the upward movement in the value of housing, as with all these types of changes it would be temporary. More important to me in this equation is the population movement in and out of a State and I believe that most if not all of these States are growing in population size. While California's population is growing it has slowed to a trickle but every person that increases the population needs a place to live and this is what drives demand for housing.
As far as municipal bonds go there should be a fair amount of concern. One thing to bear in mind is that no-one can force a State or a municipality to go into bankruptcy. The State has to send itself into a reorganization and typically through this process the bond holders are restructured and over time paid out. As a State has no equity that it can cram onto the holders of the notes and the good faith of the State's tax revenues are at stake as are future money raising requirements, in most reorganizations the bond holders retain their principle and what is re-structured are the terms of the note. In other words, while your money may get tied up in a long drawn out negotiation, it still seems like a good bet as long as the yield is good.
One thing is for sure, each of these States needs a full overhaul and the leader who takes that on is going to be met with a tank full of opposition. That said, the State that can mend itself will be rewarded with growth and prosperity and that would be a great time to own a house and those municipal bonds.
No comments:
Post a Comment