Seen on a t-shirt: Doc Brown, standing in front of his time travel DeLorean says to Marty McFry: “Above all, don’t go to 2020!” (a take on the movie, Back to the Future, 1985)
We quote this not to sidestep the abject sorrow and economic impact of losing 600,000+ lives to COVID-19 in 2020-2021, but to alert readers to be very careful of year-over-year, and month over month comparisons.
We summarize for those short on time and then discuss in greater detail below:
- The recent Federal Reserve’s Z.1 release showed stellar growth in household net worth which bodes well for the three main revenue sources of state and local government: sales, income and property taxes.
- The macro numbers overwhelm visibility of the household situation for low-paid and unemployed workers. Inequality of fortunes has grown during the pandemic. Migration has picked up after being dormant for some time. For those without accumulated net worth, migration has not been an option. Demographics will shuffle in our largest, most dense cities as population grows in less dense suburban communities.
- Weakness in commercial property in large cities showed up in the Federal Reserve’s latest Beige Book.
- Employment levels are shrinking relative to population despite favorable signs of recovery. More workers retired than might have been expected. In the latest census, general population growth was lowest in a century. This has future implications for pension funding, and entitlement programs driven by payroll taxes.
- Migration has picked up, creating pockets of growth, and fiscal stressors for places losing population.
- The federal government’s hungry need to fund its deficit is affecting financial markets, with municipal securities tagging along. For some municipal securities holders, such as banks, there’s been a reversal in municipal holdings since the decline following the “Tax Cuts and Jobs Act”, TCJA, passed at the end of 2017.
- An active hurricane and wildfire season is likely. Investor activism will continue to put greater pressure on companies to demonstrate actions to push back climate change. These pressures to visit the municipal market as well.
- Activism may grow on several fronts: among investors in ESG finance, more directly pushing for substantive change over window-dressing; and around the ballot box between right and left where controversies about the validity of the presidential election have re-framed the political culture in some places. Plus, rapidly growing property assessments/property taxes in the past have given rise to anti-tax initiatives. These tensions ramp up as we approach the congressional mid-terms.
- On balance, fiscal distress at the state and local level is at bay, thanks to help from the federal government and state/local actions. However, a few high yield and non-rated corners of the market are showing payment delinquencies and reserve draws.
Shifting Demographics and the “K” Recovery
From the Federal Reserve’s Z.1, or flow of funds, which came out on June 10: “The net worth of households and nonprofit organizations increased by $5.0 trillion… in the first quarter. The value of directly and indirectly held corporate equity increased by $3.2 trillion largely because of further gains in corporate equity prices. The value of real estate held by households increased by about $1.0 trillion. After four quarters of solid growth, household net worth is now about $19 trillion above its level at the end of 2019.” Wow. On the other side of the ledger, household debt grew as well, by 6.5% in the first quarter, mainly due to growth in home mortgages.
Migration in 2020 picked up — nearly half a million more households than in 2019. The Wall Street Journal has an interesting visual of movement here. A study by economists for the NBER showed that moves tended to be from city to suburban rings — reminiscent of the 1970’s and also of the housing boom in 2004-2007 suburban and exurban expansion.
In a recently released report on the state of housing in the US (from the Joint Center for Housing Studies of Harvard University), authors point out that new single family home sales jumped 20%; existing home sales jumped 6% — totaling the highest level since 2006. However, the difference between white and black homeownership is stark, with a gap of 28.1% in Q1 2021. Income inequality contributed, with median income of white households at $71,000 and Black households at $43,000.
On the other hand, the “COVID-19 Eviction Defense Project” points out that 16.1 million people, or 8.4 million adults were behind on their rent. You can read their research here. The project derives their data from the Census Bureau’s “Household Pulse Survey”. The survey is “designed to collect real-time data on how people’s lives have been impacted by the COVID-19 pandemic to inform federal and state response and recovery planning.”
The survey found that about 17% of renters with household income below $35 K that are not current on payments believe it is likely that they will leave their home due to eviction in the next two months. Below the $50K threshold of household income, the percent likely to be evicted drops slightly to 16.4%. You can play with their data tool to look at geographic areas suffering the most from employment, childcare, food, housing and transportation insecurity. Sorting by states and metro areas is available. In the June 15th Financial Times, Martin Wolf commented (paywall likely): “…in the US, the absence of universal healthcare and next-to-no support for retraining and job seeking makes the loss of a job mean also the loss of basic security. A modern economy becomes more flexible, not less, by separating security from a specific job.”
There has been an uptick in early retirement for some as a result of the pandemic. The Schwartz Center for Economic Policy Analysis at the New School found that 1.7 million more older workers retired than expected during the pandemic. Study authors found that the employment/population ratio fell 7.2% in April, from its pre-pandemic levels for workers older than 55, but also fell for mid-career workers (35-54) more than 4%. The upshot is that we can expect a smaller workforce going forward. This is not so good for the entitlement programs that rely on payroll taxes, nor is it good for public pensions that also rely on employee contributions. Without sensible immigration policies and retraining opportunities, shortages of workers in many occupations is likely to continue.
State/local Financial Landscape
State and local debt outstanding took off in Q2 and Q3 2020 and continued its growth in Q1 2021. At the end of Q1 2021, state and local debt outstanding totaled $3.22 trillion on a seasonally adjusted basis.
State and local revenues continued their climb despite the severe drop at the beginning of COVID-19. The chart below shows (seasonally adjusted) revenues through Q4 2020. The “V-shaped” uptick in 2020 includes unexpected revenues from sales and gross receipts taxes as well as income taxes in Q2 followed by a leveling off of those revenues. Q4, nevertheless ended at a point comfortably above pre-pandemic 2019.
In May, 2021, Pew Trusts found that 29 states recovered pandemic-driven losses (March through February 2021) but 18 states had net losses including big losers Alaska (-49.2%), Hawaii (-17.4), North Dakota (-10.9%) and Texas (-10.3%). Negatively affected states include those reliant on oil and gas as well as tourism (Florida, Hawaii, Nevada).
Property values in large city downtown areas may lighten up. From the Federal Reserve’s June 2 Beige Book: The Chicago District noted “weakness in commercial real estate and leisure and hospitality.” In the New York district “Office markets in and around New York City continued to slacken, with vacancy and availability rates continuing to trend up….” In San Francisco, “Conditions in the commercial real estate market were largely unchanged. Demand for new office, retail, and hospitality space stayed muted with reports of high vacancies and declining lease rates.” In Dallas, residential real estate activity was described as “brisk” while “Demand for office space remained weak and vacancies ticked up further.”
It is tough to forecast exactly how downtown and suburban clusters of office space will respond and re-configure longer term in the post-pandemic economy. However, given the number of companies adopting hybrid and limited return-to-office approaches, we can assert that the need for office space will be lower than pre-pandemic. This will likely affect the vitality of service businesses surrounding these clusters as well as property values/property tax revenues.
While states like California, New York, Illinois, Massachusetts and Ohio show recovery of revenues to pre-pandemic levels, these figures mask a sleeper cost: unemployment insurance advances from the US Treasury. Some states, notably California, are racking up significant repayment obligations.
Pre-pandemic, states that have taken advances from the US Treasury in order to meet their unemployment obligations had two years to repay. Generally, the employer FUTA tax is 6% but if the employer files form 940, there is a reduction credit of 5.4%, bringing the cost of the tax to .6%. If the state has a non-repaid advance after two years, the credit is reduced.
Since the “Families First” Act (FFCRA), interest payments on advances have been waived and interest accruals have been suspended. The American Rescue Plan Act of 2021 extended this waiver and accrual period to September 6, 2021 for states that have outstanding advances. As of June 14 (report published daily), nineteen States had advances totaling $53.2 billion. California’s advance balance totaled $21.7 billion or roughly half of the total. New York, Texas, Illinois and Massachusetts followed, with $9.6, $6.9, $4.2 and $2.3 billion, respectively. When these waivers cease, states and employers could face higher payroll costs, posing a potential drag on economic recovery.
Financial Market Effects
Tax reform plus federal pandemic aid significantly increased the federal deficit and consequently its funding needs. There is concern about complacency in the treasury market, while others have concerns about inflation and a potential bear market. However, one headwind is a shift in bank holdings from reserves into treasuries. According to an article “The Gravitational Pull of Zero” from the Fed Guy blog, Global Systemically Important Banks, or GSIBs, purchased $350 billion in Treasuries over the last year, “tilted towards longer dated maturities.”
Banks have increased their holdings of municipal securities as well, reversing the decline in holdings among corporate entities since the TCJA made tax exempt municipal securities less valuable. Notably, US banks increased their municipal holdings $28.6 billion over the course of 2020 and by another 4.2 billion in Q1 2021 to $516.8 at June 30, 2021. This followed a drop in bank holdings from $572.6 in 2017 to a nadir of $471.7 billion in 2019.
Recall that municipal securities are categorized as HQLA 2b (High Quality Liquid Assets), while not as liquid as Treasuries, they are a second cousin. Plus, growth in the municipal taxable market created additional supply for corporate investors. Note that insurance companies, both property and casualty and life followed a similar pattern over the course of 2020 and YOY when comparing Q1 2021 with Q1 2020.
The Z.1 release offers a few other interesting observations of changes in 2020 and Q1 2021 compared to prior years:
- Hedge fund holdings of municipal securities ended 2020 roughly level where they ended 2019. Holdings did move up $1.2 billion to $14.4 billion in Q2 2020 but fell back to the level in the chart by the end of Q4.
- State and local government “acquisition of financial assets” in Q2 2020 jumps out. (See table S.8.q in the Z.1 for state and local government). State and local governments acquired $668.8 billion Treasury securities and $24.4 billion open market securities, up from $41.7 billion in Q1 2020 and sale of $57.2 billion in Q2 2019. These derive from the National Income and Product Accounts, or NIPA, which track flows in the US economy. (Note that this table for state and local governments excludes state and local government retirement funds.)
- Bond Buyer data shows refundings jumped 107.9% YTD in June, 2020 compared to June 2019. Taxable borrowing jumped more than 230% during the same time period. This is no surprise, given the dramatic drop in rates in 2020. The effective Federal Funds Rate was 1.6 on January 30, 2020, dropped like a rock on March 16 to .25, then to .10 on March 25, then to .05 on April 2 and has stayed around .06 since the beginning of 2021. This “gravitational pull” has helped states and local governments refinance tax exempt debt with taxable debt in the absence of permissible tax exempt advance refundings which were eliminated in the TCJA .
- (The inquisitive reader may note the difference in the level of municipal securities in various tables. Table L.212 for municipal securities is not seasonally adjusted whereas “debt outstanding by sector” (D.3 and in the Federal Reserve’s opening summary is seasonally adjusted).
Finally, strong “own source” revenues plus help from the federal government has helped municipal credit stay healthy during the pandemic. We watch reserve drawdowns, bankruptcy filings and missed payments, and these have mostly occurred in high-yield, non-rated corners of the market: senior living, people-facing activities such as theaters, arenas, etc. but also a number of “tax increment” districts. These are uniquely drawn districts where incremental growth from a new revenue source secures the debt. In Missouri, for example, tax increment securities that were issued on the expected growth of sales tax from physical retail, or multi-use construction around the St. Louis ballpark, have shown stress.
Extreme Weather and the “E” part of ESG
June 1st marks the beginning of the Atlantic hurricane season. Colorado State University (CSU) published its second meteorological forecast for the 2021 season here on June 3rd. Their figures include hurricane Ana, which occurred before the official season began. Ana was located off the coast of Bermuda and weakened into a Tropical Depression. This is the second year that a named storm formed ahead of the official season. (BTW, the next name on the list is Bill. The 2020 season was so busy that they ran out of names, reverting to Greek letters.) CSU predicts 18 named storms (NOAA forecasts up to 20), eight hurricanes and four major hurricanes. These compare with averages of 14.4 named storms, 7.2 hurricanes and 3.2 major hurricanes. The current forecasts attribute higher activity to warmer sea surface temperatures, which enable a storm to pick up energy as it forms. For those wishing to go further, NOAA offers monthly briefings; with discussions of drought, sea surface temperatures, air temperatures and additional resources; the latest for May, 2021 here. The current briefing indicates that there’s a greater than 99% chance that the 2021 season will rank in the 10 ten.
While the Atlantic Coast and Gulf of Mexico may have a wet season, California drought is high, increasing probabilities for a strong wildfire season. As of May, 2021 2,000 fires had already been recorded. January 2021 was one of the driest in the state’s history. The 2020 wildfire season was record-setting, including a “giga-fire” that burned over one million acres in seven counties. PG&E is installing equipment that will help the company better pinpoint areas prone to wildfire in order to limit the scope of purposeful power shut-offs to prevent damage. The NOAA Climate Prediction Center’s hurricane and drought forecasts may be found here.
The Texas freeze brought blackouts last winter, when a weakened jet stream brought icy cold weather to the south. There were more than 150 deaths as a result and an estimated $200 billion in property damage. See this article by the Climate Adaptation Center in Sarasota, written January 27, 2021 just ahead of the February Texas freeze.
An active and harmful hurricane and wildfire season could push companies along to reduce their carbon footprint. Cities and counties are beginning to do the same, with climate action plans popping up across the country at the local level. Just “Google” “climate action plan” or click here. Corporate investors will pressure the companies they own. Investors in the municipal market don’t typically have the inclination or ability to pressure individual municipalities to change. But most fund families have at least one or many “ESG” funds where their clients can express their desire to influence environmental, social and governance change. Each fund family has its own methodology for qualifying an investment as “ESG compliant”. Several nonprofit organizations are now setting out standards along with a handful of private companies certifying ESG and labeling municipal bonds “green”.
An active flood season, may finally push Congress make changes in FEMA’s National Flood Insurance Program. Congress and a host of local nonprofit agencies have struggled to reform FEMA policy for years. A strong editorial in The Hill in May made the case for change, but importantly, for transparency for homeowners. The need to put FEMA on more self-sustaining footing could raise premium rates on many. Lower-income homeowners in coastal locations may drop their insurance if prices reach unaffordable levels. A destructive storm season on the heels of pandemic recovery could put many into a desperate financial and humanitarian situation.
A Resurgence of Activism
The pandemic also put the spotlight on inequality, and has unleashed greater activism. In the early days of manufacturing, we saw a similar emergence of unionization, walkouts and strikes for safety and higher wages. Auto and steel workers eventually came to be revered as the image of the hard-working American man, who was able to provide for a middle-income lifestyle, put kids through college, all without a college degree himself. Recall the symbolic signing by President Trump of his executive order imposing tariffs on steel and aluminum flanked by hardhat steelworkers in March 2018.
As manufacturing globalized in the 1970’s and beyond, it was replaced on the one hand with lower paid service jobs and on the other, higher paid office jobs. The first group suffered decline in their standard of living and increased dependence on government supplement. Today, it looks like we are entering a second wave of unrest, unionization and activism. This time, repetitive factory work is found in packing, warehousing and shipping activities (aka Amazon and other online purchasing and fulfillment). In addition, customer-facing retail service employees (food and drinking establishments, grocery stores, hospitality facilities), frontline healthcare workers and gig workers are under great pressure to fulfill orders quickly and face new workplace dangers made prevalent by the pandemic.
Some companies have begun to offer higher wages to attract and retain employees. Some employers warn of inflation and loss of small business, but more money in people’s pockets means more spending and less reliance on government subsidies for survival across federal, state and local governments.
See a related article (paywall likely), “The Coming Age of Disorder Will Favor Commodities” by John Authers of Bloomberg, underscores some of the throwback of current trends to the 1970’s.
…and at the Ballot Box
The controversy about who won the latest presidential election continues, and we observe emerging clashes among hyper-partisan politicians and voters, playing out in the arena of ballot initiatives as well as efforts to control the ballot box. (If you would like a quick primer about “direct democracy” and ballot initiatives from our “wayback machine”, click here but please forgive links that are now dead).
Last August, 53% of Missouri voters voted for “Amendment 2” which would have expanded Medicaid. The Republican state legislature refused to provide funding for the expansion and the governor rejected the initiative. This article points out that 230,000 Missourians and rural hospitals would have benefitted from the expansion. In addition, one study showed that the measure would save the state a significant amount of money and the state would have received $1.1 billion additional aid under the American Rescue Plan if they had expanded Medicaid.
In Mississippi, nearly 60% of voters approved a medical marijuana constitutional amendment. The measure was overturned following a lawsuit filed by the GOP mayor of Madison. The governor opposed the measure as well. Like Missouri, Mississippi activists are hoping to expand Medicaid in the state through a future ballot measure.
The New York Times picked up on this trend as well (here). Politico has an article about efforts to take over key secretary of state elections in order to have more control over the running of elections. These efforts follow the controversy by President Trump to influence Georgia Secretary of State Brad Raffensperger to alter the count of Georgia ballots. Rep. Jody Hice, who voted against certifying the 2020 electoral college results, said he is running against Raffensperger “to stop Democrats before they rig and ruin our democracy forever.” (Raffensperger is a Republican.)
