The
cost of the 2011 cutbacks in federal spending will fall most directly
on consumers and retirees by scaling back Social Security, Medicare,
Medicaid and social spending programs. The population also will suffer
indirectly, by lower federal revenue sharing with U.S.
states and cities. The following chart from the National Income and
Product Accounts (NIPA, Table 3.3) shows how federal financial aid has
helped cities shift the tax burden off real estate, although the main
shift has been off property taxes onto income – and onto consumption
(sales) taxes.
State and local revenue, 1930-2007.
Untaxing
real estate has served mortgage bankers by freeing more rental income
(the land’s site value) to be paid as interest. Property taxes have not
absorbed anywhere near the rise in debt-leveraged housing and commercial
prices. However, this has not lowered the cost of housing for most
people. New buyers must pay a price that capitalizes the property’s
rental value. Less and less of this payment has taken the form of local
property taxes. More and more has been paid to mortgage lenders as
interest. So cutting property taxes has simply left more revenue to be
capitalized into higher debt-financed prices.
While
homeowners saw their carrying charges rise, they nonetheless felt more
affluent as real estate prices rose – inflated on easier and easier
credit terms. Prices rose faster than mortgage debt as long as (1)
interest rates were declining; (2) loan maturities were stretched out
(ultimately reaching the point of zero amortization rather than the
old-fashioned 30-year self-amortizing mortgages); (3) down payments were
shrinking toward zero (rather than requiring 20 percent equity as used
to be the case) and indeed as “liars’ loans” led prices to be bid up
recklessly; and finally (4) cities refrained from raising property taxes
as fast as market prices were rising. This left more revenue to be
capitalized into higher prices, providing capital gains that home owners
were encouraged to treat like “money in the bank” – by taking out home
equity loans. This rising mortgage debt was increasingly important in
enabling people to maintain their living standards, especially as they
had to pay more for housing. So what appeared to be affluence and rising
net worth from the value of one’s home on the asset side of the balance
sheet found its counterpart in debt on the liabilities side.
From
the local fiscal vantage point, these debt-leveraged price gains
represented uncollected user fees for the site value provided by public
infrastructure and rising prosperity. The bankers ended up with the
rising flow of rental value, not the cities. This obliged tax collectors
to look to other sources of revenue. So homeowners paid out what they
seemed to be saving in modest property taxes in the form of rising sales
taxes and income taxes.
By
2008 these financial system’s easing of credit terms had reached its
limit. No more room for credit inflation remained, so speculators began
to withdraw from the market. (They accounted for about one-sixth of
demand for housing.) When the credit spigot was turned off, prices
plunged – leaving the debts in place. (So taking out a home-equity
mortgage was not really like drawing down money from a piggy bank after
all. Years of future income had to be diverted to spend for past
shortfalls.)
Now
that federal aid is falling – along with revenue from sales and income
taxes – local budgets are falling into deficit. But for many cities and
states, their constitutions and regulations prevent them from running
deficits. So they face a number of hard choices.
It
is hard to raise property taxes back toward earlier rates, because the
rental income already has been pledged to the mortgage bankers. To tax
heavily indebted property would lead to more foreclosures and
abandonment. And the Obama Administration’s hope that banks somehow will
use the Federal Reserve’s tsunami of cheap (0.25%) reserves and credit
to re-inflate a new real estate bubble is in vain, because bankers have
little interest in lending to property that is still sinking in market
price. It is easier to speculate on interest-rate arbitrage with the
BRICS and get a foreign-exchange premium as well, or simply to play the
market. Banks report winnings in the derivatives trade day after day,
with nary a loss – an indication of how poorly their hapless customers
and other outsiders must be doing! So the path of least resistance for
most cities and states is to cut back spending on public services, and
above all on pension plan contributions.
The
ultimate sacrifice (and the aim of financial predators) is to sell off
public land and buildings, roads and other transportation services,
sewer systems and other basic infrastructure. In this aim, the
investment bankers are being aided and abetted by the credit ratings
industry, threatening to downgrade cities that do not sell off their
public domain. In this respect the financial end-game of privatization
is similar in the United States to pressures by the European Central Bank to force the indebted PIIGS economies to engage in privatization sell-offs, Third World and post-Soviet style.
Just as in Europe,
when revenues are squeezed and something must give – either debt
service, payment to pensioners or current payments to labor – the
financial sector is seeking to take all the available surplus for
itself. This puts creditors in the forefront of today’s class war
against labor.
On the eve of the September 2008 financial crash, cities such as Birmingham, Alabama and Chicago
already were looking for ways to cope with the fiscal squeeze imposed
by political pressures from the major local campaign contributors – the
real estate and banking sectors – to cut property taxes. One seeming
path of little resistance was to gamble in the Wall Street financial
casino, hoping to make easy gains rather than making landlords, wage
earners or consumers pay higher taxes.
Landlords
and bankers encouraged this speculation as an alternative to taxing
property. Landlords wanted to pay less in property taxes, and banks knew
that whatever rental value buyers could save in the form of lower taxes
would end up being used to bid up prices to capitalize into debt
service for mortgages to buy properties up for sale.
Here
is the dilemma that states and cities now face: So much urban property
is sinking into negative equity territory that a rise in property taxes
will lead to even more foreclosures and abandonments, and hence even
lower fiscal returns. To avoid this, cities are seeing Chapter 9
bankruptcy as the main route to free themselves, especially from
problems that stem from an unwarranted trust in bankers to help them out
of the earlier fiscal squeeze by putting them into losing financial
gambles. Orange County in California successfully sued Merrill Lynch to recover damages, and Birmingham also was awarded recovery payments from JP Morgan Chase.
Birmingham and Chicago as microcosms of the national debt squeeze
Now
that financial fraud has been decriminalized for all practical purposes,
most financial victims are obliged to sue for reimbursement in civil
court without much help from prosecutors. Alabama’s state capital Birmingham
is a case in point. After a predatory financing arrangement to upgrade
its sewers in 2008 forced its Jefferson County into bankruptcy, the
Securities and Exchange Commission (S.E.C.) negotiated $75 million in
fines and reimbursement of fees to be paid by JP Morgan Chase as lead
lender and negotiator for the complex interest-rate swaps they had
advised the country to take, ostensibly to protect its economic
interest. The banks also forfeited nearly ten times this sum ($647
million) in termination fees. But the court-appointed receiver grabbed
the $75 million settlement for payment on the debts the country still
owed.
As
usual, the banks had paid the fine and made reimbursement without
admitting any wrongdoing. To the financial sector, deception and fraud
is part of the game, after all, not a tactic that can be prosecuted as
criminal. They paid their fines without admitting any wrongdoing, and
without even admitting the S.E.C. charges. They merely paid up and kept
silent – while the Justice Department and Internal Revenue Service were
still in the time-taking process of ruling on legal claims brought by Jefferson County.
The case prompted bankers and bondholders to bring pressure on the
state of Alabama to take responsibility (that is, take on the debt
liability) all on behalf of statewide taxpayers, and to demand that all
lawsuits brought for financial fraud to be dropped.[1]
“Responsibility” is supposed to be only for debtors, not for the
financial sector itself. This is how the banks have managed to rewrite
the laws, after all.
Jefferson County
is now debating whether to declare Chapter 9 bankruptcy to free itself
from debts that can be paid only at the cost of disrupting economic
continuity and living standards. The city’s debt quandary is a microcosm
for the U.S. economy as a whole. Its
lowest-income residents are burdened with financialized charges for
sewer-system debt payments so far beyond their ability to pay that they
face the same fate as Latvians, Irish and Greeks: As the local economy
shrinks, they must move in order to find jobs – in places less
debt-burdened and hence lower-cost. The “free market” choice is to
emigrate to flee the debts imposed on their economies and on themselves
personally.
Well-to-do Birmingham
families have yards large enough to have their own septic tanks as an
alternative to paying for access to sewers, but lower-income families
living in small houses or apartment buildings lack this option. One
county commissioner asked: “Why should the poor have to pay for the
ill-gotten gain of some of these banks who poisoned the well in the very
first place?”[2]
Other commissioners demanded that bondholders “bear the entire cost of a
$20 million fund that is being created to help low-income residents pay
their sewer bills.”[3]
But
the government usually provides relief only for creditors – above all,
relief from criminal prosecution for their business plan that involved
making loans beyond the debtors’ ability to pay. Some states have
fraudulent conveyance laws to prevent this, as well as to prevent banks
from misrepresenting the quality of their loans to outside investors.
There are laws to punish appraisers who give false appraisals, and
mortgage brokers who fill in false income reports to qualify for loans.
But the S.E.C. has seen its staff and budget slashed and deregulators
appointed to oversee its affairs. It has no authority to prosecute, only
to make recommendations to the Justice Department, where Attorney
General Eric Holder has followed the Obama Administration’s support of
Wall Street, feeling no obligation to live up to the promises to make
that a change from the Bush Administration’s similar lax behavior.
The
financial sector recognizes a dimension of economic behavior that
textbooks politely refrain from citing: the ability to capture
regulatory agencies, gain control of the courts and buy control of
politics. The Supreme Court has ruled that corporations have the same
rights as individuals to contribute to campaigns, a euphemism for buying
the loyalty of politicians and judges, and obtaining veto power over
regulatory appointees. Corporations pay lower income-tax rates and are
free of value-added and excise or other sales taxes paid by consumers.
Unlike
real people, corporations cannot be sent to jail. Corporate shells
shield owners and managers from criminal prosecution for the wholesale
frauds that have left Countrywide Financial, Bank of America, Citibank,
JP Morgan Chase and other pillars of the banking community free to make
civil settlements for deceptive policies without admitting wrongdoing.
And whereas individual crooks need to pay their own lawyers,
corporations pick up the tab for their managers, while contributing
generously to politicians who rewrite the laws to decriminalize fraud
and deceptive business dealing. The corporate-backed media applaud
politicians who insist that families “take responsibility” for their
unemployment risk, debts and health care – while bailouts free the
wealthy from having to suffer losses on bad loans.
Rhode Island
recently rewrote its laws to place bondholders ahead of other
creditors, including pension recipients. Under the new law, “city
officials who intentionally fail to pay bondholders can be removed from
office or held personally liable for the payments.”[4]
In contrast to the pro-debtor trend of legislation since the 13th
century, wealth at the top of the pyramid takes precedence over retired
schoolteachers and other public employees. The effect has been for the
city of Central Falls, Rhode Island, to seek Chapter 9 bankruptcy protection to avert a 34 percent cut in pensions to its retirees in order to pay bondholders.
Rhode Island is not alone in giving legal priority to bondholders. “Illinois
has some of the strongest bondholder protections anywhere, which
explains how a state that began its fiscal year with $3.8 billion in
unpaid bills from last year – and whose pension system has less than
half of the money it needs – is able to keeping selling bonds. State law
requires Illinois to make ‘an irrevocable
and continuing appropriation’ of tax revenues into a special fund every
month that can be used only to pay bondholders.”[5]
Chicago
has balanced its budget not by taxing finance and real estate gains,
but by selling off its roads and other basic infrastructure. Much as in
feudal Europe, the leverage is financial. Privatizers are
charging tolls and even installing parking meters on the city’s
sidewalks to charge cars for parking by the minute. New York City
has slashed is public subway and bus service, extending commuting times
and making life harder. It has privatized its television and radio,
replacing public airtime with commercial advertising.
The
ending of federal revenue sharing will exacerbate local budget
constraints. The fact that many cities and states have constitutional
requirements of balanced budgets – just as Republicans advocated for the
federal government in the 2011 debt-ceiling agreement – requires that
taxes be raised, public services cut, or assets sold off. California’s
Proposition 13 prevents the state from raising property taxes in
keeping with market prices, tying its hands fiscally and obliging it to
commercialize its once-great university system. Students must now take
on enormous education debt for what formerly was free or subsidized. New York City’s
real estate tax likewise favors large investors and wealthy homeowners,
at the expense of co-ops and condominium owners in apartment buildings.
The rising rental value that local tax collectors relinquish does not
lower housing costs; it merely enables the land’s site value to be paid
to bankers. Rising debt-inflated housing prices have priced the city out
of the market as the manufacturing center it formerly was. Its textile
buildings and other industrial properties have been gentrified, leaving
it a one-industry (finance) town focused on Wall Street.
At
the international level, Irish voters confirmed the policy of taking bad
European Central Bank advice to put the interest of bondholders first
by taking bad bank loans onto the government’s balance sheet and taxing
the population to make up the losses, even at the cost of imposing a
generation of debt-strapped depression on their economy. This is the
self-destructive road to debt peonage that the IMF and World Bank forced
Third World countries to follow for many decades. The
fact that this ethic reverses centuries-long social values promises to
make the great debate of the 21st century over the issue of which debts
are paid and which will not be – and how much debts should be written
down.
Notes
[1] Mary Williams Walsh, “A County in Alabama Puts Off Bankruptcy,” The New York Times, August 13, 2011.
[2] Michael Corkery and Kelly Nolan, “Alabama Bankruptcy Fight Hinges on Sewer-Rate Increase; Impact on Poor Bedevils Deal,” Wall Street Journal, August 11, 2011.
[3] Michael Corkery and Michael Aneiro, “Alabama County Rejects Creditor Plan but Delays Bankruptcy Decision,” Wall Street Journal, August 13, 2011.
[4] Michael Corkery, “Bondholders Win in Rhode Island,” Wall Street Journal, August 4, 2011.
[5] Mary Williams Walsh and Michael Cooper, “Faltering Rhode Island City Tests Vows to Pensioners,” The New York Times,
August 13, 2011. The article adds that: “The federal bankruptcy code
says pensioners and general-obligation bondholders are both unsecured
creditors, stuck at the back of the line and treated as equals. But
there is maneuvering room in the welter of state and federal laws.”
