by guest contributor, Peter Fugiel, Ph.D.
Anticipated drops in local property taxes will most likely cause the states to intervene. And while they’re at it, they need to introduce necessary local government reforms.
Backdrop: In the summer of 2012, Zillow commented to the market, “U.S. Home prices have dropped more than during the Great Depression.” The leading home listing service reported that U.S. home prices were finally beginning to show some improvement. Prices had dropped a record 26% since 2006. Despite modest signs of a real estate recovery this year, the big hit to property tax values is still looming. For most real estate markets, the big hit will occur three to five years out from now, as more and more homeowners demand that their tax assessment levels reflect reduced market values.
Although the U.S. bank settlement has cleared many distressed units from the bank shadow inventory, the more important federal agency foreclosed inventories are still on the agency books. High late loan levels in most markets are also a continuing negative sign, indicating that many households are still going late on their loans, for whatever reason. And finally, depending on the local market, home prices are anywhere from 10 to 40% off of their pre-2006 price levels. It may take a decade for those prices to recover. In no-growth and some struggling suburban markets, home prices may never return to their pre-2006 levels.
Feds broke a housing finance system they now cannot fix: The political deadlock in the U.S. over housing finance is expected to continue. What Washington and its high-flying GSEs broke in the mortgage financing industry remains broken. Timely disposition of foreclosed units on the GSE books is not occurring, even though realtors are reporting a dramatic decline in supply of desirable properties for sale. This year’s annual home sales level, just under five million units, is a solid number which indicates the size and depth of the American home markets. Cash buyers are still plentiful and there is pent-up demand from first-time buyers as well.
However, the availability of mortgage credit is constrained as the requisite credit scores are high by historical standards. There is no new distressed property recapitalization plan anywhere in sight. An earlier Treasury idea of allowing the national banks to issue ’covered bonds’ which would reflect the banks’ own credit on mortgage pools has stalled out. What modest lending that is being done is dependent on the old federal conduits of FHA insurance (which is having its own severe late loan problems), and FNMA/Freddie, which look very much these days like diminishing financial entities.
Three kinds of U.S. home markets according to current stress levels: There are three kinds of home markets in the U.S., according the current stress on prices. The first group (20%) includes the severely impaired home markets that require a unit preservation strategy to reduce continuing population losses and to improve rental options for formerly owned units. The next group (40%) includes the more numerous struggling metro and Sunbelt markets that are suffering from insufficient lending to take advantage of the great local home prices. The third group (the remaining 40%) includes the equally numerous upscale, suburban and growth areas that may have some home price problems. In this group, long-term demand is not considered a problem.
The mistake most of the business press has been making about the American ownership market is its attempt to explain local market trends using national statistics. The American home markets are as differentiated as they have ever been. Permanently expensive markets like the Silicon Valley and Boston are not easily compared to the U.S. median home price markets in Texas and North Carolina. The fundamental distinction that has to be made between very weak local markets, in Ohio and Michigan, for example, and struggling suburban markets in growth areas, like Atlanta and Orlando, is seldom made.
Many economically declining urban home markets in the Northeast and Midwest, those typically associated with FHA lending, will remain severely stressed. There will need to be a new federal ’unit preservation’ strategy in these markets. In the FHA markets, the lack of demand from credit-worthy buyer households is the main problem. In contrast, the big problem in struggling suburban markets is the huge gap between distressed unit prices and pre-bubble prices. The struggling suburban markets that are suffering from this price gap need new low down payment lending programs that better match lower household incomes to newly adjusted home prices. These mostly newer metro markets can close the gap between distressed units and willing seller price levels over time, using normal supply and demand mechanisms. Lender risk in the distressed suburban markets is much lower than in FHA markets.
The upside to bringing the struggling suburban markets back is that home prices in these markets now appeal to a much wider number of good credit, but starter, households. Private lenders, to date, are not serving this crucial market segment. FHA may not be the right insurance program to bridge the suburban gap.
Big drops in property tax revenues will force the states to intervene: There are such gigantic fiscal forces loose in the state and local government sector these days that the state governments themselves are going to have to step in with new revenues. Local property tax bases will continue to be under stress, as market prices take their toll on local property tax assessment levels. At the same time home values are dropping, community development patterns in many metro areas are changing due to record immigration and work force retirements. The state government will have to face both a decline in local revenues and a record number of urban communities that have lost their former middle income identities.
It will have to be the state governments that juggle the public sector’s new fiscal needs with community needs for self-improvement. Local governments will, by and large, survive this severe economic downturn. But some are going to need new revenues, or at least, new development tools. Once any one state government figures out how to adopt an expanded state sales tax, for example, it will be to that state’s and to its communities’ benefit. And as bad the state pension crisis is, local community redevelopment and local government re-structuring are an even bigger long-term governance problem for the American public sector.
Successful states should collaborate with their local governments: Once state governments learn to assume their new fiscal responsibilities, they will quickly realize that they need to re-configure their local government structures to maximize the appeal of their local communities. Too many local governments are the wrong size to benefit from the inevitable economics of having the right size. Some towns don’t even have local retail establishments, or their shopping is, by now, very obsolete. Many big cities are too big to encourage neighborhood effort and innovation. State governments are going to have to encourage local governments of all sizes to compete successfully by figuring out what their ideal management size should be and how local programs, especially for education, will need to be reconfigured.
Following are some suggestions for how state governments can help their local governments thrive:
A. Expect the state school aid formulas to continue to be under pressure due to property tax declines. New state aid programs should rightfully bring reform to the structure and management of local schools. Changing enrollment patterns in many states will have to be monitored.
B. Realize that the new economics of the American ’only cash’ economy leaves the broadened state sales tax the most practical state-level source of much bigger revenues. The states have to encourage their local governments to be full partners in the public sector financial management business. The more a state can devolve self-help community strategies, the better. Professor John Mikesell’s analysis of the very low state sales tax effort remains the expert state-by-state research on the topic. Local government use of the sales tax should be included in new state initiatives to expand the tax to its most efficient and dynamic level.
C. Most towns that are suffering through struggling local home markets have to examine their community’s appeal beyond just having nice housing. They will have to accept affordable housing as a community asset. Diversity will bring a new kind of energy. Communities will also have to diversify their tax bases to include more retail and service activity. They will have think of public transportation as the key to linking affordable housing to service sector redevelopment.
In this new age of state-local collaboration, those states wise enough to reform their local government structures to get more bang for the buck, will be stand out competitors among the states for new jobs and a greater than average increase in community income levels. The collapse of the home housing market, and the resultant decline in local property taxes, can be a blessing in disguise. New state aid to localities can usher in a new round of local government reform and modernization.
It is understandable if legislatures are loathe to take on the complexities of local government reform in an age of advanced urban development. But that is all right. There are, after all, state study commissions, citizen education efforts, and state constitutional conventions available to do the necessary ’heavy lifting.’ Getting the job done, on behalf of reconstituted state-local relations, is what is needed. This home price crash may be just what state fiscal federalism needed to bring about state tax and local government reforms.
About the Author
Peter Fugiel, Ph.D., a housing and public finance consultant in Chicago, is a frequent contributor to MuniNetGuide.com. His firm, PMN Community Services, provides research services to Chicago-area communities based on platform that combines real estate market analysis with municipal bond research.
PMN Community Services recently launched its public finance/housing research website, at USAPublicSectorMetrics.com.
Editor’s Note: The opinions expressed within this article are those of the author, and may not necessarily reflect the views of RICIC, LLC or MuniNetGuide.