Wednesday, December 28, 2011

Scarcity and Choice ... Taxpayers, Governments, Public Employees, Consumers and Companies in a No-Growth Economy

A basic principle of free market economics is the relationship of scarcity to choice.

In simple terms, we can't have everything we want whenever we want it. Based on our limited resources, we are required to choose between available alternatives, including what may be postponed until later, that which we can't afford and that which we really don't want or need.

In other words, because our resources are scarce, individuals have to make choices about what to buy or not buy, as well as in which order we intend to buy. Scarcity dictates that we choose and also prioritize our expenditures.

But it's not just that way for individuals.

The same scarcity and choice issue is true for companies, societies, states and cities as well. Choices involving scarce resource allocation, along with short and long term priorities, have to be in constant focus.

For example, choices must be made with respect to how much government is desirable, how many resources will go to aid the elderly versus to educate the young, how much will go for current consumption compared to how much we'll save for a rainy day, and so forth.

Now let's look briefly at what's happening today concerning these issues of scarcity and choice in several of our nation's cities, counties and states.

Looking Up, Detroit Faces a New Crisis details the many issues confronting Detroit and its citizens. The city's financial picture is bleak, and difficult choices must be made:

"For a city that some have declared dead again and again, the talk of late here was of renaissance — of auto industry jobs growing, new companies moving into empty buildings downtown, urban gardens blooming in vacant lots.

Then came the revelation that Detroit is poised to run out of money by April and fall deep into debt by June. Now a place that had seemed to be finding its balance is reeling once more.

A formal state review of Detroit’s books — a step that could lead to the appointment of an outside emergency manager to take over the city’s finances — was announced this week. City leaders are conducting urgent meetings with labor union leaders and financial consultants in a race to cut costs and head off further intervention.

The possibility that an outside manager could come in — one who would have broader than ever powers under a rewritten state law — has stirred new concerns among financial ratings agencies and business leaders who have fresh investments in the city. City government, meanwhile, is finding itself forced to re-examine services it provides — including buses, health care and street lighting — and shed what it can no longer afford."

Here's what Mayor Dave Bing has to say about Detroit's condition:

"Mr. Bing said he believed a solution was within reach. Significant concessions by the city’s labor unions, whose contracts do not expire until June, would have to be a part of that, city officials say, though no agreements have been announced. Mr. Bing has called for 1,000 layoffs, a 10 percent pay cut for employees and privatization of some services, though City Council members have said cuts will have to go far deeper.

The one thing that is certain is change is coming.

“Privatization, outsourcing has always been a dirty word,” Mr. Bing said. “But we’re talking about survival. And we can’t allow our 11,000 employees that we have to dictate the future of over 700,000 people here in this city.”

On the streets here, Detroiters sound frustrated — at the mayor, at the state, and at the possibility that more cuts might mean a further diminishment of their shrinking city."

Now let's move on to Jefferson County, Alabama. In Bankruptcy Filing Raises Doubts About a Bond Repayment Pledge, the extent of a government's obligation to pay its debts is reviewed.

For example, what does the term 'full faith and credit' mean when county government is the debtor and doesn't possess taxing power? Since the bonds are obligations of government, most people believe that municipal bonds will always be safe investments, but that's not necessarily the case.

Let's see what the Alabama county's bankruptcy attorney says:

"Mr. Klee, the county’s bankruptcy lawyer, said about 40 percent of America’s counties appear to be in the same boat, issuing full faith and credit debt even though they have no legal authority to raise taxes, as the term implies.

In Jefferson County, Alabama’s most populous, which includes Birmingham, officials say they had to stop paying even their general obligations because they were draining the cash they needed for essential services.

“Jefferson County made a very different decision than Rhode Island did,” Mr. Klee said. “Rhode Island put bondholders ahead of its citizens, and Jefferson County is not going to do that.”

He called the notion that a full faith and credit pledge was inviolate, and that a debtor must honor it even in bankruptcy, “a myth and a scare tactic.'"

As mentioned above, Rhode Island recently enacted legislation which placed bondholders ahead of a city's retired firefighters and police officers.

Pensions Chopped but Investors Paid tells the story about the city of Central Falls, its retirees and petitioning the state of Rhode Island for rescue funds:

"Retired firefighters and police officers in Central Falls, R.I., agreed to cut their pensions and support a plan that would likely give bondholders everything they are owed by the struggling city.

The unusual arrangement is being watched closely by municipal-bond investors and government officials across the U.S. because it could be cloned in an effort to keep borrowing costs from spiraling higher in municipalities near financially shaky cities and counties.

The deal also could spare Central Falls from a costly legal battle with retirees, while giving bond investors more clarity about the security of their investments.

Central Falls, with a population of 19,300 and a severely underfunded pension plan, filed for bankruptcy protection in August. The city has about $20.5 million in bond debt and $47 million in pension liabilities, according to state officials.

As of Monday, 82 of about 130 Central Falls workers had agreed to support the pension cuts, which will total 25% over the next five years for many recipients, said Matthew McGowan, a lawyer for about 100 police and fire retirees. A minimum of 75 retirees had to support the proposed agreement.

The state-appointed receiver overseeing Central Falls is expected in the next few days to ask a bankruptcy judge to approve the agreement with retirees, said Theodore Orson, a lawyer for the state.

Before the city's financial collapse, Rhode Island lawmakers passed a law that puts bondholders first in line among all creditors of municipalities in the state. The retirees vowed not to challenge the state law as part of the agreement.

Mr. McGowan said retirees backed the deal partly because the state director of revenue will ask lawmakers to appropriate about $2.6 million to help them cope with smaller pensions. Without the state aid, the cuts would be 55% for some. "We have many strong legal arguments," Mr. McGowan said. "But in a practical sense, they don't get you very far if the city has no money.'"

The discussion topic today isn't bankruptcy priority claims but rather the ever present fundamentals of scarcity and choice. When there is a scarcity of funds--more money owed than money available to pay the amount owed--something has to give--choices and priorities have to be made.

Will the limited funds be used to pay creditors or employees? Retained by taxpayers or paid to creditors? For the use of taxpayers or employees? Public services or retiree payments? Assistance for one city or county to the exclusion of other cities and counties? And so on.

All Americans have a difficult time ahead of us, probably a time unlike any other time in our lives.

As an economy, we're in a slow to no growth mode. We also have a great deal of existing debt to service. Regarding the tax burden, there will be lots of government spending, including transfer payments for entitlement expenditures, which will require growing tax payments.

As these burdensome debts and taxes are paid in a slow to no growth economy, consumer spending and employment will suffer. There's no escaping that troublesome reality.

It's the same worrisome story throughout the slow to no growth general economy. Yesterday retailer Sears announced serious financial problems, including ~120 planned store closings (Sears to shut up to 120 stores as sales slump). Gap and other retailers will probably follow with similar store closing announcements as well.

And let's not leave out the "zombie restaurants." See Slicing Costs, and Still Serving for a story concerning the many problems being experienced by that industry.

There's simply too much retail capacity for the amount of sustainable purchasing power today. That means fierce competition will determine the winners and losers. Retailers such as Sears and the Gap appear to be two of the losers. Losers will close stores, lay off employees and perhaps not even survive, at least in their present form.

On the other hand, Amazon and other internet sellers are winners. Probably Wal-Mart, Family Dollar and other discounters as well. But Best Buy looks like a possible loser.

Who decides the winners and losers? We do. The individual customers and taxpayers. When economic conditions are soft for an extended period of time, extreme competition prevails for the scarce funds available. That's the way markets work.

So what do markets and competition have to do with cities, counties, states and municipal bonds?

Well, it takes money to buy new things as well as to satisfy previous obligations. People are the source of all funds--not the government.

In a difficult economic environment, there's more scarcity than usual. Accordingly, we customers and taxpayers have to decide where and how to spend what limited funds we have.

So when the money runs short, someone won't get paid. That may be a worker, a bondholder, a retailer, a restaurant, a car dealer or any other party who doesn't make the "competitive scarcity-choice cut."

Regarding the citizens and taxpayers of Jefferson County, Alabama and its bondholders, here's what the county attorney says about scarcity, choice and the future:

“It’s a very reasonable step on the part of the county commissioners to conserve the money to deal with the crisis within the county,” he said, adding that he hoped that in the end the general-obligation debtholders would be paid in full, but he did not know if there was enough money. Finding out could take years."

And so it could. And most probably will.

Things really are tough today, and for the foreseeable future as well, in this slow to no growth worldwide economy.

Being alert to the effects of scarcity and the resulting real choices that must be made by all of us, including governments, is very much the new normal.

Thanks. Bob.

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