Launch Slideshow

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Borrowing Goes Bust

Borrowing Goes Bust

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    Tight credit is prompting many departments to postpone new projects and temporarily suspend others.

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    From left: Hoa Nguyen, Melika Roshandell, Jan Kleissl (assistant professor of mechanical and aerospace engineering at the Jacobs School of Engineering), Anthony Dominguez, Michael Sankur, Mandana Farhadieh, and Yoichi Shiga. Not pictured: Wen-Han Liu, Samer Naif, Andrea Tan, Roger Huang, Anders Nottrot, Hared Ochoa, and Long Sun. Photo: Dong Kim, UC San Diego

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Last month, four out of five finance officers told the National League of Cities they'll have a harder time balancing the budget next year than they did this year — which itself wasn't a walk in the park.

During past economic downturns, cities could use property tax revenues to offset lackluster sales and income-tax receipts. But in the wake of the housing market's largest decline since the Great Depression, values continue to adjust. Since taxes on this property won't be collected for 18 months, experts don't expect revenues to start inching up again until 2010.

In the meantime, let's look at the unfortunate impact of exotic loan instruments on the public sector. Like homeowners, some finance directors found Wall Street's debt-financing solutions too tempting to resist.

Some eschewed the fixed-rate loans that have historically made the municipal bond market a boring but reliable investment. Instead, they chose “buy now, pay later” variable-rate loans that are “insured” by credit default swaps, which — unlike regular insurance — aren't regulated and don't require issuers to set aside capital for potential losses. Municipal borrowing soared. According to Thomson Reuters, it more than doubled from $195 billion in 2000 to $425 billion last year.

Jefferson County, Ala., has become the poster child for what can go wrong when the engine driving all the speculation — the (unrealistic) assumption that housing prices will never stop going up, up, up — sputters and dies.

The county refinanced more than half the $3.2 billion it had borrowed to upgrade the sewer system serving its 11 cities with auction-rate securities, whose interest rates are regularly reset. When the credit rating of the county's debt insurers was lowered because of their investment in subprime mortgages, the county's credit rating fell as well. Interest payments soared. When the insurers sued the county for mismanaging its debt, the county sued them for failing to protect their client's financial interests. At press time, the city was considering filing for what would be the nation's largest municipal bankruptcy.

Not surprisingly, cities, counties, and states are holding off on issuing bonds now that tight credit is driving up interest rates. U.S. governments issued 35% less this September than in September 2007, the research firm Municipal Market Advisors reports.

Luckily, the federal government's attempts to stimulate the economy are injecting life into dormant programs.

President Bush's financial rescue plan includes full funding — $367 million — for the Payment in Lieu of Taxes program through 2012. The 60% increase is the highest ever for the program, which compensates local governments with large public land areas for lost property tax revenues.

The package also extends production tax credits for wind, solar, and geothermal projects; and includes incentives for energy-efficient buildings, electric cars, biofuels, and advanced coal projects.

And the Housing and Economic Recovery Act of 2008 provided $3.92 billion for the Neighborhood Stabilization Program, funded through the U.S. Department of Housing and Urban Development's Community Development Block Grant program.

Each state receives at least $19.6 million, and almost 100 counties and consolidated governments will receive direct funding allocations. Grantees have until Dec. 1 to explain how they'll spend the money, 18 months to obligate funds once they receive them, and four years to spend it all.