17 May 2018

Patterns of Urbanization and Municipal Bankruptcy

A significant number of American cities including its 18th largest, Detroit, filed Chapter 9 municipal bankruptcy during the long, slow recovery from the aftermath of the 2008 financial crisis. I blogged about Detroit (here and here) and Stockton (here and here) many times. As I mentioned this past week, I also published a couple of articles on the topic of Chapter 9 bankruptcy: Municipal Bankruptcy: When Doing Less Is Doing Best (download here or here) and Who Bears the Burden? The Place for Participation of Municipal Residents in Chapter 9 (here or here).

I have previously posted about some of the causes of municipal insolvency in America. Featured among them is "debt-overhang," frequently caused when a city's political leadership promises generous retirement benefits to current employees who retire many years later. In other words, city leaders of yesteryear wrote checks that their successors--and current taxpayers--must honor. Demographic matters also play a role.

You can read about another structural explanation here. In a review titled "Suburban Ponzi Scheme" Peter Leithart draws from a book about by Charles Marohn, Jr. Marohn explains that something like the debt-overhang is even more pervasive than that caused by feckless municipal politicians. Specifically, the phenomenon of post-World War 2 suburbanization could not have taken place without federal and local subsidies in the form of highway transportation (think, the interstate highway system), other infrastructure expenditures, and subsidies for home mortgages (an earlier related observation here). We don't often think of roads, infrastructure, and mortgages as examples of governmental subsidies but as Leithart summarizes,
Since World War II, suburbanization has occurred in several phases. First, “transfer payments” from state and federal government funded “local growth initiatives such as new roads, sewers, industrial parks and community facilities.” Then there was spending on transportation, especially the interstate highway system. The third phase was funded by debt, mostly “non-governmental debt including mortgages, commercial real estate loans, credit cards and more.”
What the quote misses is how the 30-year fixed-rate mortgage also represents an federal intrusion into the market. As I wrote here five years ago,
Apparently it's not enough that the federal government already subsidizes home building, buying, and selling with the home mortgage interest deduction. Anything that might bring market discipline to bear on consumer real estate transactions is anathema to big business. (And make no mistake: The construction and real estate lobbies are very big and very powerful. You might read my earlier post on American state capitalism here.)
One might wonder what problem Marohn identifies. Sure, government intervention in the market is far more pervasive then many folks realize (read an excellent review of the history of capitalism here and my earlier comments about capitalisms here) but, given what government could subsidize (say, ethanol), what's so bad about roads, infrastructure, and home mortgages? I'll let Marohn explain:
With each increment of new growth, the city assumes the long-term liability of maintaining all improvements deemed "public." This can only work if one of two things turns out to be true: the city’s growth – specifically, the increase of tax revenues from the growth catalyzed by the schemes – will “exceed the long-term maintenance and replacement cost of infrastructure the public is now obligated to maintain”; or, the city will continue to grow at an increasing speed “so as to generate the cash flow necessary to cover long-term obligations.”
In other words, financing the long-term costs of roads and infrastructure requires that those improvements correspondingly increase tax revenue. Except, they don't: "A suburban road is resurfaced at the cost of $354,000. Marohn asked how long it would take the city to recoup that money from the taxes paid by property owners. The answer is 79 years. But the road’s life-cycle is only a third of that." 

Thus, only by increasing the size of the tax base can cities currently pay for the improvements previously made. In other words, a suburban Ponzi-scheme that one of these days will prove unsustainable and ... suburban Chapter 9s!

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