Archive for January, 2010

Oregon voters passed Propositions 66 and 67 yesterday which support Governor Kulongowski’s budget proposal.  The following link will give you detail on the propositions, the vote, the key donors to each campaign and the groups advocating pro and con.  Oregon is a high income tax state and ranks high among the states with large budget deficits and high unemployment.  (See state’s post, and stress rankings chart)  This is from Ballotpedia:

On July 20, 2009 Gov. Ted Kulongoski signed two tax bills that will increase taxes in the state by $733 million through increasing the state’s corporate minimum tax, raising taxes on the state’s high-income individuals and raising income taxes on businesses.[1] In reaction to the news, several Oregon citizen and business groups geared up to use the veto referendum process in the state to try to stop the hikes.[2][3]

On October 8, 2009, the Oregon Secretary of State’s office announced that both ballot measures had qualified for the ballot. According to Don Hamilton, spokesman for the Secretary of State’s office, supporters of the measures turned in substantially more than the 55,000 signatures needed to qualify each measure for the ballot. According to Hamilton: “They filed more than twice as many [signatures]. It’s unusually high for a statewide ballot measure.”[4]

Midterm congressional elections will be lively this year.   Conditions are ripe for tax and spending initiatives and numerous recall elections are also on the popular agenda.  Budget deficits, rising taxation and runaway spending are factors leading to tax and spending limitations.  Anger at the federal government sometimes gets played out at the state and local level where people can air their views in the local media and have greater influence on budgets, tax levies and spending. 

The combination of denied credit, deeper debt, harsh taxation…led the discontented to suspect a conspiracy by the moneyed interests of the country to enslave them in a web of economic servitude.

(From David Schmidt, on the rise of the initiative and referendum movement in the 1880’s. Citizen Lawmakers: The Ballot Initiative Revolution, Temple University Press, 1991)

The same characteristics that showed up in the 1970’s and today were present in the original initiative movement.  Indebted farmers and frontiersmen who had moved out west felt that they were subject to the special interests of industrialist bankers, railroad barons and land speculators.  The boom and bust cycles of westward development left a rift between the farmers and frontiersmen and the groups that they saw as the exploiters.  It was the farmer’s belief that these greedy influences had corrupted the legislatures and that they were being taxed to help those special interests. 

In the late 1880’s the number of farm foreclosures exploded and a vast number of farms were taken over by the loan companies.  Out of this era came the Farmer’s Alliance which later developed into the Populist Party.    The right of citizens to directly create laws through the initiative movement – “direct democracy” — stems back to this time and later with the Progressive Party.  These groups were strongest in Texas, the Dakotas, Kansas, Oklahoma, Alabama, California, Colorado and elsewhere in the South and West.  Ballotpedia, a “wiki”, or open electronic encyclopedia, (like “wikipedia”) shows the following map of states that permit initiatives, referenda and constitutional amendment.

Click twice to enlarge

Click twice to enlarge

In the 1970’s rapidly rising real estate values accompanied by a tax structure that captured an increasing proportion of homeowner’s income in property taxes again led to significant voter unrest.  That time period gave us California’s Proposition 13 in 1978, passed by two-thirds of the state’s voters and reducing property taxes 57%.  In the 1960’s and 1970’s California had experienced an extraordinary growth in property values and in tax bills, largely due to inflation and dramatic increases in population.  In Massachusetts, prior to passage of Proposition 2 ½, state and local taxes grew from 103% of the national average to 124% of the national average.  Idaho, which passed Petition No 1 in 1978, had seen residential taxes nearly double between 1969 and 1978.  Later, Colorado voters passed the “taxpayer bill of rights” or TABOR which sought to significantly limit government (1992).  (TABOR has subsequently been loosened but a movement is afoot to roll back the liberalization of the original law.)

The presence of a committed and zealous individual or group is another key ingredient.  Although some dismiss these individuals or groups as “cranks”, they will persist in introducing ballot measures year after year, until something passes.  Howard Jarvis in California and Bill Sizemore in Oregon are two well-known names.  Today’s Tea Party groups are spawning new leaders in this effort. 

Demographics play a part in initiative and referenda movements as well – states with lots of retirees like Florida, Arizona and California – have ready workers with time on their hands to get petitions signed and talk with the neighbors.  In addition, the continuous migration of people from place to place has intensified demographic differences. 

The “pick-up-and-go” mindset in the U.S. has led people to sort themselves into like-minded communities – reinforcing particular political viewpoints.  “Over the past thirty years, the United States has been sorting itself, sifting at the most microscopic levels of society, as people have packed children, CDs, and the family hound and moved…When they look for a place to live, they run through a checklist of amenities: Is there the right kind of church nearby? The right kind of coffee shop? …When people move, they also make choices about who their neighbors will be and who will share their new lives. Those are now political decisions, and they are having a profound effect on the nation’s public life…In 1976, less than a quarter of Americans lived in places where the presidential election was a landslide.  By 2004, nearly half of all voters lived in landslide counties.”  (Bill Bishop, The Big Sort, Houghton Mifflin, 2008)  Another of Bishop’s key points is that interacting primarily with like-minded people tends to make a group’s political viewpoint and perspective more extreme.  Electronic social media also plays this role.  The use of the Internet, blogs, Twitter and YouTube for grass roots campaigns has made it easier to create, inform and activate like-minded communities.

The sorting, polarizing and intensifying of political views has created gridlock in many state and the federal legislatures. Maintaining the primacy of one’s political party and political viewpoints often win out over collaborating to create effective policy. “California’s primary system and gerrymandered Assembly and Senate districts, both parts of the Constitution, consistently produce candidates from the ideological extremes.  In such an atmosphere, party orthodoxy rules all, and crossing the line to compromise is political suicide.  For this reason, real, desperately needed change is blocked at every turn, and only bills like regulating tanning booths actually escape alive.”  This is from Jim Wunderman in the San Francisco Chronicle last summer.     Examples are easy to find in the state legislatures, notably California and the embarrassing New York State Legislature where Democrats physically locked out the Republicans last summer.  At the Federal level too, Republicans’ refusal to vote on any proposals from the Democrats or collaborate on sensible solutions is a further example of this polarization.

Finally, funding for initiatives and referenda has become big business for some proponents.  In California and elsewhere, gathering petitions and paying for advertising campaigns has spawned a well-funded cottage industry.  The recent Supreme Court decision permitting corporations and unions unrestricted campaign funding will inevitably reinforce the trend. 

Grassroots groups are reacting.  The Tea Party is an example of the tension between the grassroots and organized parties.  The Tea Party is a loose and in some areas unaffiliated collection of organizations.  Tea Party Nation, Tea Party Express and Tea Party Patriots are among the few national organizations.  Tea Party Patriots has accused Tea Party Nation of co-opting the name from the grassroots movement and receiving support from the GOP. is sponsoring the first national convention on February 4-6 in Nashville, Tennessee and Sarah Palin is the featured speaker.  Complaints about the hefty registration and GOP support are common.  A lawsuit erupted in Florida over the registration of the name as a political party.  The defendants argue that the name stands for “taxed enough already”.  The blog site “TPM Muckraker” has some interesting coverage of these various party disputes.

Whatever your affiliation, ballot initiatives will likely affect state and local government finance as well as governance in the next year.  It is worth following these trends.  Along with Ballotpedia, we recommend the Initiative and Referenda Institute at the University of Southern California as a good resource, as well as the National Conference of State Legislatures.

A particularly toxic form of adjustable rate mortgage is going to hit the headlines in the spring and summer of 2010 with defaults, foreclosures and workout discussions extending into 2012.  “Option ARMs” also known as “Pick-a-pay” allow the borrower to choose how much to pay each month and reports indicate 94% of all borrowers paid the minimum.  What’s the catch?  The difference between the minimum and the actual loan rate gets added to the loan balance creating “negative amortization”. 

These loans were originated in the 2004-2007 bubble period with a majority sold during the peak year, 2006.  They were popular in high cost areas, typically more exurban and inland places where houses were slightly more affordable.  A Moody’s report mentions that 54% of these loans were made in California and another 13% in Florida. The next largest origination states were Arizona and Nevada.  About 28% of all home loans originated in the 2004-2008 period in Vallejo-Fairfield (Solano County) California were option ARMs.  One quarter of the home loans originated in Santa-Rosa-Petaluma in Sonoma County were Option ARMs.  These figures are according to the San Francisco Chronicle

The following chart shows the top-10 MSA’s by size of outstanding option ARM balance, including negative amortization, thanks to Alla Sirotic of Fitch Ratings. Note that these are as of August, 2009 so the balances may be different today.  Also, these represent Non-agency RMBS (residential mortgage backed securities).



The payment option mortgage lured buyers into thinking a big, new house could be affordable.  The pitch?  The borrower thought he/she could re-finance into a more sensible structure or in the worst case, sell the house and pocket some additional equity.  Many of these loans were also used by speculators who hoped to make a profit on the sale and by holders whose files were poorly or fraudulently documented.  Articles citing homeowners who were told the loans had no risk abound.  The housing bust is driving down values and some of the 2006 vintage loans now have a loan-to-value (LTV) of 163%, making the refinance or resale prospect out of the question.

Many of the loan structures had a period of five years before the loans re-cast to fully amortizing and fully loaded interest – hence the toxic brew hitting in 2010-2012.  Around 78% of the option ARMs have yet to recast, and of those loans, 93% have negative amortization, according to a recent Standard and Poor’s teleconference.  The structures also typically carry an amortization trigger when the loan exceeds 110%-125% of the original balance, which could happen before the five year period.  The recast payments could be significantly higher than the monthly amount the homeowner deemed affordable at origination. 

A popular chart that has been circulating among the housing bubble blogs comes from Credit Suisse and shows the timeline for adjustable rate mortgage resets and option ARM recasts.  While the bulk of sub-prime adjustable interest rate mortgages have been re-structured, or are making their way through the foreclosure process, the chart illustrate how option ARMs recasts have yet to hit the fan.  (This version from the “Mortgage Insider, Matthew Padilla of the Orange County Register, updated through April 2009.)



The solution?  Moody’s concludes that loan adjustment is really the only feasible solution, short of major additional dislocation for homeowners and additional heavy mark-to-market write-downs for the institutions holding this paper.  Wells Fargo is reportedly doing just this on mortgages it owns on the books (accounting for some of the discrepancy in the numbers).  On the political front, the prospect of loan modification is highly controversial.   Some elected officials do not want to look like they favor one group of troubled homeowners over another.  Hmmm. 

Finally, the size of this coming problem is also controversial.  Credit Suisse had to make some assumptions regarding recast dates.  Since payment amounts are, well, optional, the level of negative amortization must be estimated and the time when these loans hit the trigger ahead of the five-year period is also estimated.  Some loans were 40-year, rather than 30-year, complicating the calculations further.  Moody’s and Fitch’s numbers show about $200 billion will be recast in the 2010-2012 period.  The Wall Street Journal cited $750 billion originated between 2004 and 2007 (according to Inside Mortgage Finance).  Some of the discrepancy is between publicly held RMB (residential mortgage-backed) securitizations, loans held on bank balance sheets and agency securities. Sirotic points out that Non-Agency RMBS volume is approximately 17% of the overall outstanding US mortgage market and securitized Option ARMs represent about 13% of the Non-Agency RMBS.  There are definitely more Option Arms loans that are held in bank portfolios, she commented.  So the rest are in federal agency securities, FNMA, FHLMC and GNMA, now a federal balance sheet problem.

A Barclay’s report mentions that many of these loans are already in default ahead of the recast and so should be removed from the numbers. (So is this good news or bad news?)  Housing Wire further reinforces this point:  “The prospect of option ARMs swollen with negative amortization coming to recast and defaulting on a massive scale inspires bond investor fear — and hysterical headlines — but the real fallout might be dimmed by the share of loans that have already foreclosed and no longer remain in the pool.”  Stephen Berg, MD of Lender Processing Services told Housing Wire that they only had about 800,000 active option ARMS.   Whether you think 800,000 loans and $750 billion are small or large numbers, the option ARM will punch more holes in household, government and institutional balance sheets in the coming months.

The slowdown in migration in the U.S. has significant consequences for municipal finance.  New population growth in a community has been the driving force in municipal infrastructure finance since the beginning – and the slowdown we have seen over the last two years will affect bond volume in previously high growth centers.  Borrowing to meet the needs of growth is politically easier when expectations for repayment fall on the new beneficiaries.  Borrowing for maintenance is more challenging and we expect capital spending to fall in the near term both from internally and externally generated funds.  In addition, problems from high foreclosures and developer bankruptcies have cropped up on the suburban frontier, where the slowdown in migration is pronounced.  A look at the recent census report adds an important dimension to our understanding of state and local fiscal condition.

Local movers – people who move from city to suburb and suburb to suburb are typically first time homebuyers, mover-uppers and those whose family circumstances have changed (births, deaths, and divorce).  The stimulating tax credit for first-time homebuyers plus reduced downpayment requirements (which combined to allow zero downpayment for many) has offset some of the downturn in the housing industry over the last six months – first the threat of tax credit expiration pushed some into the market and then the extension brought in some additional buyers. 

People move long distance mainly for jobs.  With many economists predicting a slow recovery for employment, long distance moves are unlikely to pick up near term.  “Long-distance migration acts as an engine of growth in many metropolitan areas…younger adults are far more likely to move than older individuals,” according to William Frey of the Brookings Institution.  (There is a small peak in migration among people in their early sixties who move for retirement.) Long distance movers tend to be college educated and professional. 

Florida:  Frey peeled back the demographics on Florida’s net out-migration, a historic trend and a surprise to many.  “The shift from net in-migration to net out-migration in Florida was especially strong for whites, Hispanics, younger people, married couples and persons with some college education…Despite its total net out-migration, Florida still attracted people ages 55 and over in 2007-2008.”  Sales taxes and health care services may perform satisfactorily under this demographic shift to older residents.  But older migrants on fixed incomes will reinforce anti-property tax sentiment in the state and there will be even less interest in supporting stressed school finances.

California: More people are staying put.  The state is the mirror image to Florida – a reflection of softening real estate costs and the weak job market in magnet states such as Arizona, Nevada and Oregon. 

Arizona and Nevada: These states’ dependence on construction will hurt in the current environment.  Arizona’s net in-migration, while still positive, has fallen by more than 54% from its peak in 2006 to 2008.  Nevada’s net in-migration has fallen more than 75% from its peak in 2006 to 2008.  At the peak of Nevada’s building boom in April, 2006, more than 11% of all employment in the state was in construction.  Arizona’s construction employment was next highest at 9.3% followed by Florida at 8.6%.  This compares with a U.S. level of 5.6%.  Managing through this drop-off is critical.  The negative comment in Moody’s downgrade report on Arizona’s upcoming COP sale caught our attention: “lack of institutionalized best financial management practices”. 

Trouble in suburbia: The outer suburbs are suffering the fall in migration with increased crime and squatters in empty houses.  Some writers, such as Christopher Leinberger declare that exurban communities will become the next slums.  ABC Australia covered this phenomenon last spring: “…it is easy to find signs that America’s relentless suburban expansion may have petered out…Streets remain incompletely paved and poorly lit, the legacy of a builder that declared bankruptcy.  And transient renters have replaced homeowners who were forced out by the foreclosure crisis.”  Prince William County, where the subject community is located saw a nearly 40% drop in property values according to the county’s 2010 budget message.  The “Aa1” rated county is entering the year well-positioned for the challenge, but has cut the budget across the board, eliminated services and increased classroom sizes.  The county has taken down its capital improvement budget by 64% since last year.  Other governments that are less well managed may not fare as well. 

Cities and dense metro areas well-positioned for economic recovery: “Migration matters,” according to the Economist December 19 edition.  “Economic growth depends on productivity and the most productive people are often the most mobile…When clever people cluster they can bounce ideas off each other.  This is why rents are so high in Manhattan.  Robert Lucas, a Nobel economics laureate, argues that the clustering of talent is the primary driver of economic growth.”

I have placed a longer discussion of these issues for download when you click Migration Report.