TARP Aid For The Cities-A Few Thoughts

Last night in a post I noted the plea by several cities including my hometown of Phoenix for a piece of the TARP action. I want to follow-up with a couple of thoughts but before I do, let me update the story.

The city of San Jose has jumped on the bandwagon and wants some too. They suggested the nice round number of $14 billion. They figure they contribute 2% to the nation's GDP and thus deserve 2% of the pie. It might be overreaching a bit since their entire annual budget is $3.3 billion. If you don't ask you never receive.

Anyway, San Jose and the rest list three critical needs that cause them to come hat in hand to the TARP till. In no particular order it is immediate cash requirements, infrastructure spending and unfunded pension liabilities. Let's take a quick look at all three.

To the extent that a local governmental entity is out of cash, facing bankruptcy or whatever dire straits they might have gotten themselves into, I think it should be pretty much up to the state in which they happen to be located to work things out. Most if not all states have the ability to borrow substantial sums of money and it's in their best interest not to have their cities conducting going out of business sales. There is usually a pretty complex arrangement among states and cities with regard to how they carve up the tax revenue kitty, so let them rearrange the relevant shares and take care of their own business.

I could go on forever about infrastructure investment. Let me just do two things. One direct you to a good article in the Wall Street Journal on Friday that reminds once again that government spending for stimulus including infrastructure investment is a zero sum game. Government spending cannot create wealth, only the private sector can, so money directed to the cities for infrastructure projects only succeeds in rewarding the beneficiaries while some other part of the economy pays the price. In essence, Phoenix gets work for its unemployed while Omaha pays the bill.

Second, the cities have a propensity to allocate their infrastructure dollars, particularly the mega-federal type dollars, to marginal projects. Phoenix is a great example. We are about to open what amounts to no more than a demonstration light rail system. The project will serve a minute portion of the city yet the cost even with massive federal support is inordinately expensive. If history is any guide, operating it will only drain the city's finances more. This project was rammed through at the height of the housing bubble when Phoenix was awash in tax receipts. As we now know, it might have been wise to put some of this aside rather than investing in infrastructure.

The talk of needing TARP money to fund unfunded pension liabilities is both surprising and expected. Surprising, since for many years, local and state governments have vehemently insisted that their pension plans were in great shape while refusing to divulge the details needed to objectively verify that claim. It's expected because a number of experts have been asserting for some time that this is the issue that could cause a complete meltdown of a local or state governmental entity. San Diego has already demonstrated just how ugly it can get when overly generous benefits run up against funding realities. This is one huge problem that TARP can't solve. You might well throw the entire $700 billion at it and not make a dent. Besides, there is a vehicle that already exists at the federal level to solve these problems. It's called the Pension Benefit Guaranty Corporation.

In the WSJ today, Mark Sanford, the governor of South Carolina has an essay titled "Don't Bail Out My State." Among other reasons, here is one he cites as a reason for his opposition to directing TARP or any other type of federal aid to state and local governments:

Do you now have to be a financial "bad boy" to win?

Community bankers tell me that they are now at a competitive disadvantage for being careful about who to lend to, because others that were less disciplined will get a federal bailout. This is also true for states. Those that have been fiscally responsible will pay for or lose out to the big spenders. California increased spending 95% over the past 10 years (federal spending went up 71% over the same period). To bail out California now seems unfair to fiscally prudent states.

Was the economist Herb Stein wrong when he said that if something cannot go on forever, it won't?

Medicaid grew 9.5% annually over the past 10 years. That's unsustainable. But if Congress opens the checkbook now, there will be no reform.

At the very least, if federal money is to be thrown to the states and cities then at least let it come with strings attached. It should not be free and should be advanced in the form of a loan with a decent return to the federal government. Done in that manner, the borrowers will have to budget their expenditures in such a manner as to provide for repayment.