The COVID emergency is officially over.  The Russian invasion of Ukraine is not over.  Now what?

Not raising the U.S. debt ceiling is currently the single most important threat to the U.S. economy and standing on the world’s stage.  Federal surpluses shrank 43% in April 2023 compared with April 2022.  Major reasons include a slowing economy plus higher interest cost on the federal debt.  Other reasons include the change in capital gains revenues from robust equity market rallies in 2021 contrasted with selloff and volatility in 2022.  Federal Reserve transfers to Treasury have also shrunk, given higher interest being paid on commercial bank deposits and meager earnings in the current context on low interest bonds held by the Federal Reserve.  Combined, these factors make it more difficult for Treasury to keep borrowing below the debt ceiling and pulled the “X-date” earlier than previously estimated. 

The X-date is when the government can no longer pay all of its bills and must make difficult payment prioritizations.  Congressional Budget Office director, Phillip Swagel’s May 1 press release on this issue may be found here.  Political standoff between the White House and House of Representatives doesn’t help.  Speaker McCarthy could lose his speakership if he appears too flexible.  The White House wants a “clean” bill to raise the debt ceiling with deficit cutting discussions held separately.  Meanwhile, none wish to touch the great gorilla in the room, Social Security and Medicare.  We were at this impasse in 2011, when Standard and Poors lowered the U.S. bond rating.  A debt ceiling impasse happened again in 2013. The Government Accountability Office (GAO) outlined how the debt ceiling impasse of 2013 affected the Treasury market and the broader financial system here.  Michael Gleeson, of the National League of Cities, outlined “How the Debt Ceiling Debate Impacts Local Governments” here.

We divide this commentary into four parts.  First, some economic, and financial thoughts, with focus on the municipal market.  Second, we discuss workforce shortages that impede economic growth in our post-COVID world today and going forward.  Third, we discuss student debt and its important overlap with workforce shortages and the housing market.  Finally, we focus on some solutions that are emerging at the state and local level.

Thoughts on the municipal market:

  • Lower municipal volume is likely to continue, given higher interest rates, but also market volatility, especially around the debt ceiling standoff. Total new issue volume reached $107 billion in the first four months of 2023, and it looks like full year volume may come in lower than last year, closer to $350 billion, if that. April 2023 volume was just over 24% lower than April 2022.
  • In addition to slower income tax revenues at the federal level, state and local governments that levy income taxes saw slowdowns as well.  Thirteen states offered tax relief in 2021 and another 14 did so in 2022, according to the National Conference of State Legislators, NCSL.   In 2023, (mid-fiscal year) an additional 13 states have approved revenue reductions.  Economic slowdown in 2024 and continued inflation could lead to higher spending pressure.  Filling public sector vacancies, could require higher compensation.   Completing infrastructure projects face headwinds.
  • Fortunately, states and most local governments have enough cushion for now, thanks to stimulus and higher revenues.   However, if Congress approves recissions of unspent stimulus money (and the President signs-off), state and local fiscal conditions could tighten.
  • Property tax protests are likely to jump, and revenues will be lower, as work-from-home becomes partially or fully permanent.  Office vacancies especially challenge commercial property, not just in large urban centers but suburban mall and multi-use “edge city” as well.  
  • There could be less turnover in residential real estate, particularly for those that bought or refinanced during the ultra-low interest rate period.  Hopefully state and local governments that use some form of real estate transfer tax (such as Florida’s documentary stamp tax and New York’s mortgage transfer tax) budget conservatively.
  • We are likely to see slower rates of paydown in CMBS and RMBS (commercial and residential mortgage-backed securities) as well.  Real estate prices are starting to come down in both sectors, albeit slowly. The Federal Reserve’s Financial Stability Report from May, 2023 shows commercial real estate (CRE) holdings of banks at $2.2 trillion, or 61% of total CRE outstanding as of Q4 2022 (nonfarm, nonresidential CRE). 
  • On the positive side, smaller cities and even rural communities have seen population growth.  See COVID migration discussion here, here, here and here. In some cases, that migration has meant more car traffic, and in the cities, less transit ridership.  Some of these changes are permanent, while some are already showing signs of reversion.
  • Lower goods purchasing has eased supply chain constraints and tech demand as homes and schools are stocked up. 
  • The movement to spending on services and experiences is less interest-rate sensitive since people do not generally finance these purchases (although they can be credit card heavy).  The inflation in service costs is a natural offshoot from COVID lockdowns, “relief” demand, and shortage of workers. 
  • Stated differently, as Dana Peterson, chief economist of the Conference Board eloquently said on Bloomberg, recent layoffs are mostly confined to the “pandemic darlings”: tech, finance, real estate, construction, transportation and warehousing.  Asset prices in these interest-rate sensitive sectors boomed during many years of low interest rates. 
  • The impact of Russia’s invasion of Ukraine continues to reshape energy markets, production, and consumption.  This confounds movement towards green energy. Agriculture and the US oil and gas producers have done well.  Counterpoints between fossil fuel advocates and greens have intensified highly partisan and extreme geopolitical arguments.  In the U.S. such battles are state-based depending on concentrations of natural resource vs. “knowledge-based” production – but Congress reflects the divide as well.  I discussed some of these points in more depth in an April, 2022 commentary here.
  • The destruction of so much productive capacity in Ukraine and Russia (on many fronts) plus geopolitical tensions with China also affects the production of electric vehicles (EVs) which, in the U.S., are hungry for minerals.  Lyric Hughes Hale, editor-in-chief of Econvue, recently interviewed Daniel Yergin on her podcast.  He commented that EV’s consume 2-3X more copper than cars today.  He sees greater demand for minerals alongside less demand for oil.  Yet it takes 15-25 years to develop a new mine and billions of dollars.  Unstable governments make it difficult to get long-term projects like that completed.  The conversation then veered into the subject of “permitting delays” on major resource projects.   Yergin’s editorial in the Wall Street Journal includes these issues here (April 12, 2023). 
  • The top 100 public pension plans had $187 billion in directly held real property as of December 31, 2022. There were $751 billion in private equity and $517.5 billion in “Other Private Funds” held. Also notable, was a 51% jump in Reverse Repurchase Agreements held, above holdings in September, 2022. The largest investment category was Corporate Equity, at $1.743 trillion compared with $2.182 trillion at December 31, 2021, or 38% and 42% of total cash and investments respectively. Total cash and investments dropped about 11% YOY. (Figures are taken from a panel of the 100 largest public pension systems as of 2012 Census of Governments by the U.S. Census Bureau, Quarterly Survey of Public Pensions.)

With that, we offer Part Two which discusses a few critical sectors with labor shortages.