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August 07, 2013

City of Broken Promises

What I would prefer is that you should fix your eyes every day on the greatness of Athens as she really is, and should fall in love with her. When you realize her greatness, then reflect that what made her great was men with a spirit of adventure, men who knew their duty, men who were ashamed to fall below a certain standard. If they ever failed in an enterprise, they made up their minds that at any rate the city should not find their courage lacking to her, and they gave to her the best contribution that they could. -- Pericles of Athens

When I was a kid, my mom promised to take me to an amusement park on our summer vacation if I brought home nothing worse than a B on my report card, and performed some extra chores around the house. Weeks later, I fulfilled my part of the bargain, triumphantly presenting my mom with a report card with nothing but A’s and B’s on it. I pointed to the spotless yard and tidy bedroom. Visions of a fun day at the amusement park already filled my head. I told all my friends about my impending trip, and saved every nickel I could for toys and food at the park.

However, as the big day came near, my mother sadly told me that the trip was off. Her hours at work had been cut back, and we could barely scrape up rent and gas money. We simply could not afford a day trip to the amusement park. I was devastated, and incandescently angry at my mother. She had promised, and I had fulfilled my part of the bargain. I don’t remember the details of my tantrum that day, but it wasn’t pretty, and it ended up with my mother blowing her stack and banishing me to my room for a couple of days.

It was only in later years that I realized how sad and ashamed my mom must have been for breaking the promise she had made to me. She had no choice in the matter; there was simply no money to waste on that kind of entertainment. We were barely getting by as it was. She made the promise to me when times were relatively good and she was getting plenty of overtime, and she had made the mistake of assuming that the status quo would continue indefinitely. She was mistaken, but the mistake wasn’t malicious. Things just...didn’t turn out like we expected. But it was years before I really forgave my mom, and I never did get that day-trip to the amusement park. It remained a bitter seed in my heart for a long time afterward.

The same dynamic is now playing out in towns and cities across America: promises were made to then-current public-sector workers -- years and even decades back -- that cannot now be met. The problem confronting politicians, city managers, bond issuers, bond buyers, and citizens of cities and towns across the nation is one of responsibility for those past promises. Who pays? Who’s responsible for making those promises good? Should those old promises be made good, especially if they were made in bad faith?


From the article:


"This is happening in too many cities and towns across America, where social services, because they can be cut, are cut," financial analyst Meredith Whitney, founder of Meredith Whitney Advisory Group LLC, told CNBC. "(But) because pensions and bonds constitutionally cannot be cut, they're the protected class. I think you're going to see a real issue of neighbor against neighbor on these very issues."

But as Detroit has demonstrated, budget-balancing service cuts only lower the quality of life in a community, chasing residents away and further eroding the tax base. Raising taxes, on the other hand, discourages new business expansion, further reducing revenues. For cities and states that have failed to fund their pension promises, it's a death-spiral.

There is bitterness and anger on all sides, and recriminations flow like water. Much of the anger is perfectly justified. Many of the pension promises made to public employees were made in the spirit of “IBG,YBG”, or “I’ll be gone, you’ll be gone” before the repercussions of these promises were felt. Unions pressed for ever-richer benefit packages and pensions, and politicians and city managers alike found this an easier way to placate the workers than raising their per-hour wage. Twenty or thirty years ago, the consequences of these decisions seemed far-off and relatively minor. Taxes could always be raised; bonds could always be sold. The workers accepted the promises of future benefits in lieu of (or, more usually, in addition to) raises in pay. All the players in the drama accepted the status quo and assumed it would continue.

But as time went on and the fabric of America changed, it started becoming alarmingly clear that these rich pension and benefit promises could not be kept. This much was clear even before the 2008 recession. A changing economic landscape, changing demographics, and skyrocketing benefit costs put many cities in a terrible bind. Actuarial games could be played with pension contributions; simply assume a higher rate-of-return on investments, and voila! An underfunded pension could magically be made healthy just by fiddling some numbers in a spreadsheet. All the money that would have had to go into the pension could instead be diverted to municipal projects, payroll, and social programs. More patronage jobs could be offered to political allies and their families. Skyrocketing healthcare costs for both current workers and retirees could be made on a “pay as you go” basis, and hidden in general-fund spending. This strategy worked for a time (a surprisingly long time), but as America’s phase of explosive growth slowed and the population continued to age, the problems got harder to paper over.

A city really only has a few ways to generate revenue. The first is via taxation. The second is via “fees”, a loose term that encompasses things like parking meters, permits, certain licenses, and so on. Theoretically these “fees” are optional, but in fact are simply another form of taxation. Then there are state and federal grants and payments. When these revenue streams prove insufficient, many cities turn to the bond market to borrow money -- usually for infrastructure projects like streets, schools, civic arenas, and the like. In recent decades, the bond market has allowed cities to borrow funds willy-nilly at rock-bottom interest rates because municipalities were deemed nearly riskless in terms of default. However, it’s become increasingly obvious in recent years that the bond-issuers gravely underestimated -- and thus under-priced -- the risk. Ratings agencies have begun to downgrade both states and municipalities as the risk profiles become more alarming.

So here we are now, with many major cities facing some brutal arithmetic. To honor their pension and benefit promises to their current and former employees, they’d have to spend the bulk of their revenue, leaving little for city services. A city owes these services to its citizens; that’s what taxes are for. The implicit promise of government taxation is that your taxes will be used to fund the project or service the taxes are collected for. The bond markets are no longer endless fonts of easy and cheap money, and the debt overhang that many cities already carry are discouraging them from taking on even more debt.

So what does a city do when it can no longer buy, borrow, or tax its way out of trouble?

It goes bankrupt. Bankruptcy is an acknowledgement that many promises will be, must be, broken if the city is to survive. A city’s only purpose is to serve the people who live in it, so it would seem to be logical that the taxpayers would be foremost in the minds of the officials working to solve the problem. But alas, it is not so. Municipalities now apparently exist to service public employees and bond-holders more than their own citizens, which means that city services -- police, fire, garbage pickup, public lighting, sewer, street repair, and so on -- must go begging to satisfy the creditors. Yet without these public services, what purpose does a town or city really serve except to siphon money out of the pockets of people who live there? Cities caught in this death spiral -- Detroit is the prototypical example -- hemorrhage citizens as they flee to less dysfunctional homes. The tax rate continues to go up even as the tax base shrinks. Eventually, the whole machine freezes up and stops.

Cities are not forever. They are not permanent constructs, any more than states or nations are. All will pass away. There was a time when Detroit was one of America’s greatest cities, but that time is long past. Perhaps it is time to simply allow this city -- and others destroyed by mismanagement and historical forces -- to pass into history. Many people cannot bear to do this. They see the houses and streets and buildings and parks and decry the waste. But this is a form of the sunk-costs fallacy. The city cannot be saved by throwing good money after bad.

Adults must understand that all promises are provisional, and hostage to future events. Nothing is absolute; nothing is fixed. A broken promise needn’t be the outcome of fraud or unfair dealing -- it may simply be due to changed circumstances. Public employees (retired and otherwise), bondholders, politicians, taxpayers: all need to understand this basic truth. It may be true that mismanagement, dishonesty, and fraud led a city into ruin, but it is also true that these seeds of destruction were sown decades before. Many of the malefactors have shuffled off this mortal coil, and are now beyond any but God’s justice.

Above and beyond all else, though, what we are finding is that debt-financed spending is a disastrous way to run an economy. This is perhaps the most iniquitous and corrosive aspect of the Keynesian philosophy, which has held sway in the public sector for so long. The notion that governmental entities cannot go broke, that they can spend virtually without limit and without fear of default, has been conclusively proven to be nonsense. Yet at every level of American government, from the smallest town to the Federal government, the public sector still behaves -- and spends -- as if there will be no reckoning. Taxpayers are viewed not as masters, but as cud-chewing cows to be milked as needed. Then shock and alarm when the cows move on to greener pastures.

Socrates argued in Crito that men owed allegiance to their city, perhaps more than they owed to their own families. This notion is predicated on the belief that the city is a moral as well as a physical place; that there is a moral contract (a promise, if you will) that the citizen will faithfully adhere to a city’s laws and mores in return for the protection and opportunity the city offers. But Socrates’ view of the city as a repository of wisdom and law has suffered grievously in the centuries since his passing. Cities and towns are not abstract constructions of morals and law, but rather collections of human men and women, who are prone to all the weaknesses and vanities all mortals are heir to.

Cities can and do fail. It is wisdom to know when this is happening, and to move on, and to apply the lessons learned to the next home.

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posted by Monty at 08:17 AM

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