TOPICS > Economy

Global Credit Crunch Takes Toll on State Economies

October 10, 2008 at 12:25 PM EDT
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Wall Street's credit freeze sparked a global economic crisis and forced U.S. cities and states to tighten their budgets. Elizabeth Brackett reports from Illinois about the state's financial woes then Chris Hoene of the National League of Cities explains the national downturn.

ELIZABETH BRACKETT, NewsHour correspondent: Just two years ago, Neptune Construction was bringing in $75 million a year in sales.

Now the heavy equipment that was the backbone of the company’s sewer and water main installation business sits silently in the yard, waiting for the Nov. 7 auction date.

Neptune closed its doors Sept. 2, laying off a staff that was as high as 250 during the busy construction season. Owner Tom DiOrio and his partner and chief financial officer, Ben D’Andrea, still can’t quite believe that their nearly 30-year-old business went down so fast.

BEN D’ANDREA, Neptune Construction: Initially, when I went into the bank and started talking to the bank about renewing our lines of credit, they had felt it wouldn’t be a problem. This was early in the year.

As the year went on, the bank philosophy changed. They had started looking at our documentation more closely. They had started reviewing cash flow closer. And when it finally came down to it, they said, “Sorry, we can’t help you.”

ELIZABETH BRACKETT: One of the reasons Neptune needed to expand its credit was to pay bills while waiting to get paid for services rendered. Neptune installed water and sewer lines in this subdivision west of Chicago in a $2 million project for the state. Though the project was completed last month, Neptune has received only half of what it was owed.

BEN D’ANDREA: I don’t know the reasons why they were delayed, but it definitely added pressure to the cash flow, which, again, was one of the contributing factors to us closing the doors.

ELIZABETH BRACKETT: Illinois state Comptroller Dan Hynes acknowledges the state has $1.8 billion in bills that it can’t pay. Nearly $400 million is owed to groups that provide Medicaid services.

Hynes says the government will eventually pay its bills, but on a much slower basis than in the past.

Illinois is not alone. At least 12 other states are also in jeopardy of not paying the bills.

DAN HYNES, Illinois state comptroller: This is the worst we’ve seen. And I think what’s even scarier is that, you know, all the signs are pointing in the wrong direction in terms of what we can expect for the remainder of the fiscal year.

ALEXI GIANNOULIAS, Illinois state treasurer: We did worst-case scenarios, and we are pretty much at that line now, where we are as bad as we could ever have imagined.

Dearth of credit impacts economy

ELIZABETH BRACKETT: State Treasurer Alexi Giannoulias says Illinois, like many other states, is facing a perfect storm of fiscal problems. The state's general revenue fund has dropped by $590 million in the first quarter of this fiscal year.

ALEXI GIANNOULIAS: Any time you talk about a decrease in revenues, any time you talk about an increase in unemployment, business owners are closing up shop, that's all revenue that comes to the state.

And when you take into consideration, you know, the casinos and lottery, which are losing significant revenue this year already, and when you also talk about the fact that in our office interest income is going to be down -- to give you an example, we got about $426 million in interest income alone just in our portfolio. That number dropped last year to $375 million. This year, it might be as low as $130 million to $170 million.

So you're talking about a $200 million to $300 million drop in just two years or a year-and-a-half. And, obviously, when that revenue -- and that's $200 million not going to the state. That's going to have an enormous impact on our ability to provide basic services for the people of Illinois.

ELIZABETH BRACKETT: The late state payments, particularly the Medicaid payments, are having a disastrous effect on the nonprofit agencies that serve the state's most vulnerable constituencies.

The state is $800,000 behind and four months late with its Medicaid payments to Blue Cap, a social service agency that serves 400 developmentally disabled kids and adults.

Just like private businesses, the agency has also tried to extend lines of credit to keep the agency running until state payments come in. And just like private businesses caught in the credit crunch, Blue Cap has been turned down by banks.

Executive Director Tony Di Victorian, a former priest, fears the worst for his program.

TONY DI VITORRIO, Blue Cap: Our challenges here just get deeper and deeper. And it's terrifying, in a word, because I can be responsible for myself and for my family, and there's a lot of people that are involved here, but as executive director, you begin to feel responsible for the whole organization.

And you begin to recognize that not only the people that we serve, who are very vulnerable and need our service and supports to be safe and to live decent, full lives, but I have staff who are also vulnerable.

ELIZABETH BRACKETT: Keith Kynsoer has been receiving services from Blue Cap for about 10 years. He says he doesn't know what would happen to him without the program.

KEITH KYNSOER: Well, I could be on the streets. I could be a bum, could be in jail. So if it wasn't for these people, I wouldn't be here.

ELIZABETH BRACKETT: As state vendors struggle, Hynes says he thinks the federal government needs to help out.

DAN HYNES: The federal government can and should play a role, whether it's in terms of just liquidity and providing cash flow assistance.

There has been precedent in recent years of the federal government offering more Medicaid dollars for states on an emergency basis. I think that should definitely be considered, because the Medicaid budgets are really hurting state budgets. We're on the front lines. We are the ones who are going to be counted on to help people in their time of need.

ELIZABETH BRACKETT: For companies like Neptune, it's too late for any federal or state help. But emergency Medicaid payments could help Keith Kynsoer and organizations like Blue Cap survive this latest financial crisis.

Credit crunch hitting state budgets

RAY SUAREZ: Illinois isn't the only state feeling the pinch. For more on how the economic crisis is affecting states and local governments throughout the country, we turn to Chris Hoene, the director of policy and research at the National League of Cities, an advocacy group for municipal governments.

And, Chris, Elizabeth Brackett reported Illinois can't pay $1.8 billion worth of its bills. Are there many states in that level of trouble, in that deep?

CHRIS HOENE, National League of Cities: Maybe not quite that deep, but there are a lot of states and localities facing similar challenges. What's happening in Illinois is actually illustrative of two major challenges facing state and local governments.

The first is the short-term borrowing problem that was mentioned by the business owner in Illinois, which is states and localities collect their revenues at different intervals, sometimes quarterly, sometimes twice a year, but they pay their weekly and monthly bills through short-term borrowing, much like a small business.

With the credit crisis the way it is and credit having dried up a bit, that money isn't available or the cost of that money have gone up because of interest rates, and so states and localities aren't able to get that short-term borrowing.

RAY SUAREZ: Which states or which regions are having the worst problems?

CHRIS HOENE: Well, the worst problems overall are in those parts of the country where the housing markets have been declining the most. So the Southwest, Nevada and Arizona. There are some deep problems with state budgets in Florida and Georgia and South Carolina.

We're seeing problems up and down the eastern seaboard, from Virginia up through Connecticut and Rhode Island, including the state of New York. And then the industrial Midwest, Ohio and Illinois, are both facing budget problems.

Snowballing catastrophe plays out

RAY SUAREZ: How does that work? When there's a sudden decline, for instance, in the value of houses or widespread foreclosures, what are the steps before it starts to affect the state's balance sheet?

CHRIS HOENE: Well, for the states, it happens much more quickly, because the major sources of revenue are sales taxes and income taxes. So what happens is people stop spending money and making major purchases. If incomes and wages are flat or they start to go down, those impact sales taxes and income taxes very quickly. So states tend to see this happen first.

For localities, the major source of revenue is property taxes. And there's always a bit more of a gap between what happens with housing markets and what happens with property taxes, because the assessment on those housing values, it has a one- to two-year lag on it.

And so we're just now starting to see the effects on local budgets in terms of what's happened with housing markets.

RAY SUAREZ: Are these factors starting to bite, just as states themselves have even greater obligations for unemployment insurance to provide social services for people in economic trouble?

CHRIS HOENE: Right. The other side of this equation is that the costs for state and local government always go up during these periods. Crime tends to go up. That means that there needs to be more public safety resources expended.

There are more people in need, particularly in terms of temporary assistance, things like homeless shelters or people thrown out of their homes because of foreclosures or maintaining vacant properties. So the costs go up just as the revenues start to go down.

RAY SUAREZ: Now, obviously, a foreclosed house comes off the rolls immediately, but is there also a slow-moving disaster on the way because a lot of houses are going to have to be reassessed. They just aren't going to be worth as much anymore and thus won't yield as much real estate taxes.

CHRIS HOENE: Yes, that's exactly what we're just starting to see happen right now. So a survey that we do every year of city finance officers showed that property taxes are declining in 2008 for the first time in probably a decade.

But that's probably indicative of changes in the housing market that were happening in 2007. So what's happening today with housing values still declining, the fact that we think that likely hasn't hit bottom, means that we're still two or three years away from seeing the full impact in terms of the bottom for local governments.

States incapable of borrowing

RAY SUAREZ: Now, in our report, we saw a state treasurer talking about how much less the portfolio for Illinois is earning. Are there states that are in trouble of, for instance, not being able to pay their pensioned employees, their retirees?

CHRIS HOENE: That may be the case for some state and local governments. It's not clear yet what the extent of that problem is. A lot of it has to do with those portfolios and what happens with the market right now.

What clearly seems to be happening is that their portfolios will decline, in terms of those pension funds, and that means that they're going to have to cover their obligations out of their annual budgets, which means that's going to be another pressure, right?

Their revenues are going down. Their costs are going up. And they're going to have to allocate more of their annual budget to these pension funds.

RAY SUAREZ: Now, states don't have the same kind of flexibility that the federal government has, do they? I mean, a lot of them by law can't run a deficit.

CHRIS HOENE: Right, for state and local governments, they have to balance budget by state law under their state constitutions. And so these budget gaps that we're talking about -- and we're looking at probably 15 states with midyear budget gaps right now, we're looking at cities with a 3 percent gap in 2008 -- those gaps have to be filled by the end of the year.

And that's going to mean cuts in services, or it's going to mean drawing down reserves, or it's going to mean raising revenues in some way, or some combination of the three.

RAY SUAREZ: And if a state's just trying to do the kind of thing that states do, improve a suburban arterial road, fix a water main, they're going to have trouble bonding, aren't they?

CHRIS HOENE: Yes, that's the other side of this equation, as well, that the longer-term part of the short-term borrowing story is that cities and states are entering the bond market. And there aren't takers; there aren't buyers of these bonds.

That's how they fund those infrastructure projects, their roads, their bridges, their sewers. They have spent a lot of money in the last seven or eight years catching up to long-term deficits in that regard. But what's happening with bond financing is likely going to curtail that in the future.

RAY SUAREZ: Chris Hoene of the National League of Cities, thanks a lot.

CHRIS HOENE: Thank you.