Municipal Deflation (Abridged)
By Frederick Sheehan
At the bottom of the Depression the number of beleaguered municipalities kept rising until 1935, when there were at least 3,252 municipal issues in default.
Professor Herbert D. Simpson of Northwestern University informed the 45th Annual Meeting of the American Economic Association in 1933:
[There is] real estate ’speculation’ carried on by municipal governments, in the sense of basing approximately 80% of their revenues upon real estate and then proceeding to erect a structure of public expenditure and public debt whose security depended largely on a continuance on the rate of profits and appreciation that had characterized the period from 1922-29.
The financial difficulties of local governments in consequence both of the inflation and deflation of real estate values demonstrates strikingly the unwisdom of a revenue system concentrated so heavily upon real estate.
In The Crash and Its Aftermath, A History of Securities Markets in the United States, 1929-1933, Barrie Wigmore explains how municipalities increased spending because tax receipts rose:
Since tax receipts rose, local governments could leverage growth through bond issues. Outstanding municipal bond debt doubled in the 1920s.
A.M. Hillhouse, author of Municipal Bonds: A Century of Experience, wrote in 1936:
[T]he major portion of overbonding by municipalities arises out of real estate boom.
The same thing has happened today. States and municipalities, who borroweded $23 billion in 2000, borrowed $215 billion in 2007. There are at least three reasons to think current municipal problems today will be worse than in the 1930s:
- First, the latest real estate bubble today has probably been much bigger and more leveraged than in the 1920s.
- Second, state and local government expenses today are not as easy to cut–hamstrung by bloated government retiree pension and health benefits.
- Third, property assessments lag current prices. Towns want to hold the status quo so are in no hurry to tax properties at falling market values.
This promises to be a fierce battle.