Eerie calm of municipal bonds belies US cities’ tax plight

In early 2020 Francis Suarez, mayor of Miami, Florida, was basking in a boom. His city was thriving and seeing buoyant revenues from property sales and taxes.

No longer. When Covid-19 struck the US, Mr Suarez became the first American mayor to test positive for coronavirus. He soon recovered from the disease, but Miami’s fiscal health has not. “We had a $20m surplus going into Covid and $25m deficit after — and started the fiscal year [in October] with a $35m deficit,” he told me last week.

He is not alone. “I am in a situation where I have spent down our reserve funds . . . cut every dime and nickel we can,” said Bill Peduto, mayor of Pittsburgh in Pennsylvania. “But we are still facing a $75m deficit out of a $600m budget.” Jenny Durkan, mayor of Seattle, Washington, echoed: “Our revenues have been decimated. Without help we are facing depressionary conditions.” 

Investors and federal policymakers should be paying attention to these concerns — not least because Seattle, Pittsburgh and Miami are probably among the better resourced and better run American cities. The fiscal crises in these municipalities have not yet attracted much attention outside the US. That is partly because the individual local deficits don’t seem too worrisome when viewed in isolation. It is also because of the sleepy nature of the $4tn US municipal bond market, which is two-thirds owned by retail investors who buy such assets for their tax-exempt status and rarely trade them.

In any case, muni bonds prices have performed well in recent months because investors have piled in looking for yield — not least because the sector’s default rate from 1970 to 2016 was just 0.18 per cent, compared to 1.74 per cent for investment-grade corporate bonds.

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But while the muni bond market might seem peaceful, the real-world situation in cities and municipalities is alarming. Not only could the current fiscal squeeze eventually raise default rates, deficits are undermining the civic services needed to support recovery. “At the time we need emergency personnel the most, we will be forced to lay off police officers and firefighters and medical staff [without help],” Mr Peduto warns. Mr Suarez adds: “We are looking at the possibility of having to let go policemen and firefighters — those on the front lines.”

The reason is that Covid-19 has revealed the best and worst aspects of the US federal structure. On the plus side, the devolution of powers has enabled some local officials to combat the pandemic more effectively than the federal government. In Miami, for example, Mr Suarez imposed a face-mask mandate, cutting the spread of the virus. In Seattle, Ms Durkin launched widespread testing with good results. 

But a problem with this governance structure is that it can create endless policy contradictions and inefficiencies. In Pittsburgh, the city does not set health policy, but it does run emergency services and was expected to combat Covid-19. “We face an expansion of our duties and responsibilities but without the authority,” says Mr Peduto.

Worse, the responsibility for finding medical supplies has often been tossed on to local leaders, sparking a vicious and inefficient form of competition. “We had a hunger games situation,” laments Ms Durkan. This could be replayed when (or if) a Covid-19 vaccine arrives, she warns, unless the federal government provides co-ordination.

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But the more immediate headache is fiscal: municipal tax revenues have collapsed as jobs vanished, wealthy residents sometimes fled and commercial activity slowed. Stimulus aid has also been capricious. In March, Washington unveiled a package earmarked for cities and states. But only cities with populations greater than 500,000 qualified for direct payments. Thus while Suarez says Atlanta qualified for $88m in direct payments, Miami did not get anything. Nor did most cities. And the mayors say the money has not trickled down from states (not least because they face record budget shortfalls of $105bn this year).

Is there a solution? The obvious one is for the US government to swiftly produce a new stimulus package and insist this provides direct support to cities. Another is for Washington to invoke second world war-era emergency powers to co-ordinate the production and distribution of medical supplies and any future vaccine. 

But this looks unlikely to happen soon given the current political gridlock. Indeed, the fate of any future stimulus plan is uncertain. It is both a tragic indictment of the country’s dysfunction and a reason for investors to feel nervous as Covid-19 continues to rage.



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