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Category 4 – External, Economic/Technical

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Economic Recession

Pension Investment Losses Require Catch-Up Contributions

Change in the Base of the Local Economy
Shifting Demographics
Inflation

Economic Recession

Economic recession is one of the most visible causes of financial distress. Declining consumer spending, dropping property values, and unemployment have direct negative impacts on revenues like sales taxes, property taxes, and income taxes, not to mention implications for increased expenditures for programs like social services. Visit ltfp.gfoa.org for updates on key economic indicators.

 

Symptoms

  • Declining housing starts. This shows a willingness on the part of consumers to make a major investment, indicating confidence in the future direction of the economy.
  • Employment. Employment is a proxy for the income currently being generated in the economy.
  • Purchasing Managers Index (PMI). This is an index composed of a national survey of purchasing managers on their expectations and current activities. This is considered an indicator of how well businesses are doing: businesses that are doing poorly cut back their purchases, while those that are expanding and doing well increase them. This index is available from the Institute for Supply Management (ISM).
  • Contracting industrial production. This is an estimate of all the non-service goods currently being produced.
  • Consumer confidence. This indicator measures how willing people are to spend in the economy. Consumer confidence figures are formulated using survey data, which is then organized into a scale, with a score of “100” being neutral. 
  • Building permits. Building permits show consumer and business willingness to make a major investment. Building permit figures are available from the U.S. Bureau of the Census. Local community development departments can provide more precise local information.

Change in the Base of the Local Economy

Contributed by Richard Longworth

Fiscal distress occurs when the traditional basis of a local economy declines or goes away, or changes in such a way that it provides less support to the community than it once did. 

The most infamous cause of economic decline is decline of a local industry or natural advantage. When the port silts up, the mine plays out, the factories close, or a new and better highway is built somewhere else decline sets in.

A second form of decline takes place when the traditional economy changes in such a way that it provides less support to the community. This happens when local production stays strong but, because of improved technology and productivity, it no longer provides the employment it once did. The Midwest, for example, produces as many manufactured goods as ever, and exports even more, but employs fewer persons.

High taxes don’t necessarily lead to economic decline. The cities that are thriving in the new economy – Chicago, New York, London, Tokyo and other global cities – are high-cost cities. Yet they draw the most desired companies, employing the most skilled and educated workers. The most desirable employers are willing to pay for the privilege of being in high-cost cities because of the benefits they provide. 

Symptoms
  • Declining population. One of the most serious causes of decline as people leave for better opportunities elsewhere.
  • Brain drain. The best-educated and most ambitious young people leave to seek economic opportunity elsewhere. 
  • Real estate decline. Commercial and residential property occupancy and prices fall. As these prices fall and as jobs decline, so do tax revenues. 
  • Good jobs disappear. Investment doesn’t necessarily cease in declining local economies, however, the investing companies usually seek low-wage and low-skill labor and usually demand little from public services. So while jobs do not disappear, good ones do. In addition, these new companies tend to be transient, often taking advantage of incentives: these are precisely the companies that are taking jobs off-shore now. 
  • Shift in population composition. New residents don’t stop coming, but new residents are often coming because it’s the cheapest place they can find to live. Hence, these towns tend to attracting the poor, the unskilled, and the under-educated, making it difficult to attract the quality of employers that could reverse decline. 
  • Declining school enrollment. Except in cities that are drawing immigrants, school enrollment in declining cities falls steadily over the years. Since state aid to schools largely depends on enrollment, funds available to these schools also falls.

Shifting Demographics

Contributed by Douglas C. Robinson and Charles L. Sizemore

Changes in demographics can cause fiscal distress by increasing the relative size of population segments that consume more in public services than they contribute in tax dollars.

Demographic world image
Shifting demographics can also lead to distress if the demands of new constituents are not consistent with existing capacities. For example, a growing immigrant population may require bilingual education, requiring the development of an entirely new capacity in schools. Changing age demographics can also be a significant factor. Areas with slow-growing and aging populations may find themselves with excess capacity in their schools. Large fixed overhead costs combined with fewer children means a higher cost per pupil. Meanwhile, these same areas might face acute shortages of facilities for elderly citizens.

Perhaps most importantly, demographics play an important role in the level and composition of retail spending. Men and women in their late 40s tend to make the biggest overall impact on consumer spending. An area with a larger percentage of its population approaching that age should benefit from strong spending, a healthier job market, and greater sales tax revenue. Areas in which a large segment of the population has passed that critical age should experience much lower growth, all else equal.

Symptoms
  • Aging population. Population distribution information from the Census Bureau can be used to look for a population that is aging and reaching a potential tipping point in which a significant number will be entering retirement and might be looking to sell their houses and move. 
  • Coming youth cohort. Today’s newborn is a kindergarten student five years from now, making an increase in birthrates a precursor of increasing costs. This information can be obtained informally by canvassing local area doctors, maternity wards, and nurses. Formal numbers are preferable, though there is a time delay that can be significant.
  • Changing consumption patterns. Business retention surveys from the local economic development program could be used to find out what kind of businesses are expending or shrinking. What kind of product do they sell? Who are their customers?
  • Changing residential mix. What age and income groups are moving into the area? What kinds are leaving? What are the rough numerical estimates of each? Talk to local real estate agents as they are likely to see trends in these areas.

Pension Investment Losses Require Catch-Up Contributions

Contributed by Girard Miller

 

The stock market meltdown during 2008 wiped out 25 percent of most public pension plans’ investment portfolios. The result for many is a huge increase in their unfunded liabilities, with funding ratios dropping nationally from about 85 percent in 2007 to 65 percent in 2009 on a real-time basis. Many public plans will use actuarial smoothing to delay the impact of the required amortization of these investment losses, but ultimately the average public employer may soon face pension contribution increases of 20 to 40 percent. 

Symptoms
  • The asset-liability ratio of the pension fund is lower than 75 percent, using today’s market values.

If you have not already obtained a “marked to market” valuation of the pension plan’s investment portfolio and requested a candid projection of the future annual contributions that will be required to amortize those losses, then that is where you should start your analysis.

Inflation

The costs to local government may escalate faster than revenues such that it becomes more difficult to fund the same level of service over time. Employee health-care benefit costs, for instance, have been increasing much more rapidly over recent years than the revenues of most local governments. Energy prices proved a vulnerability for many governments during their spike in the summer of 2008.

Symptoms
  • Increasing commodity prices, particularly gold prices. Gold has traditionally been used as a hedge against inflation. General rises in other commodity prices can also reveal inflation.
  • Dollar weakness. As the dollar weakens, a dollar buys less.
  • Increasing long-term interest rates. If the bond market believes that the Federal Reserve has set the fed funds rate too low, expectations of future inflation increase, which means long-term interest rates increase relative to short-term interest rates - the yield curve steepens. If the market believes that the Federal Reserve has set the fed funds rate too high, the opposite happens, and long-term interest rates decrease relative to short-term interest rates - the yield curve flattens.

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