American Finance and Political Culture

by Richard K. Brawn, CCGA, MPA | June 11, 2008

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Epiphany: De-concentration of risk is a desensitizing narcotic to finance that serves to increase the sum total of capital loss. 

A microcosm of American politics

Last night I sat through three hours of my hometown city council meeting on the city budget. I was the only member of the public present. The discussion was interspersed with a mind-numbing discussion of funds that had been moved around like the pea in a shell game. At the end, a decision was made to increase the deficit. California requires the cities to participate in a ‘no-deficit’ charade. State law forbids city deficits, but the state will not act as long as the cities keep the deficit invisible. My city keeps its deficit invisible by not doing maintenance (other cities use unfunded retirement plans, etc.) The deferred maintenance game is horrendously expensive because of the damage it incurs. For example, if a roof needing $100 in repairs is left unrepaired it will result in thousands of dollars of structural rot and damage. The deferred maintenance just for roads is now in excess of $70 million on about $200 million of replacement cost. The deferred maintenance is exacerbating the normal wear and tear on roads at the rate of about $10 million per year and rising. Yet the city will only allocate some $3 million for road repair. Why only $3 million? Because the police need to be paid, the fire trucks need to be replaced, etc. Paying road repair would mean staff cuts that would paralyze the city services. The City Council has directed the City Manager to look into borrowing money. The City Manager suggested capital spending projects be oriented on increasing tax receipts. That suggestion did not fly because city services must be provided regardless of their relation to tax receipts. This financial situation being experienced by my city is being repeated at every level of government and in every corner of the United States. 

The city council chose to accept over $5 million in unrecoverable capital destruction rather than face the budget restrictions created by its past actions and the anticipated revenue stream. This is one city, but it shows that despite the horrendous cost of the decaying infrastructure, politically attuned people will not reduce services in order to fix infrastructure. Essentially, no political body is going to concern itself with financial soundness until the voters want that to happen. 

I use this example not to pillory my city but to make clear how deeply indebted government has become and the near total lack of public interest. One can disagree/criticize the decision or look to the situation for insight. The city is now faced with rising prices which have the effect of transforming these revenue ploys into the equivalent of negative amortization/Ponzi scheme. Unless some political event arises to create public interest in financial soundness, this path ends in financial collapse. This political situation can be traced to the Federal Reserve Board. 

The Federal Reserve Board manufactured interest rates that have decimated the public interest in saving and magnified the public desire to borrow. Politics is just a mirror image of the culture of excess money that the Federal Reserve Board has created. Perhaps something will come from the insurers of municipal debt who will pick up on the unseen risk. Or, perhaps the numskulls buying municipal debt will realize the degree to which capital assets of some municipalities are like swiss cheese. 

From small to big

Because everyone is linked though the complexity and diversity of the financial system, risk is dispersed and so wealth loss will be widely distributed. Money to pay for the insurance claims must come from somewhere. That “somewhere” looks very much like will come from liquidation of assets in the very same market the folks who bought the insurance are participating in. As the loss of wealth passes through government in the form of reduced tax revenues, choices will have to be made. Either services will have to contract or government debt will have to expand. Whether that will be possible will depend upon how much of a financial threat degraded infrastructure poses to the revenue streams of government entities when the tide turns. Anyone who knows the life cycle of American cities is keenly aware of the erosion of municipal finances over time. The point I am making is that de-concentration risk is a desensitizing narcotic for risk managers. The lack of sensitivity then allows acceptance of higher levels of the risk-rot with the result that the sum total of capital loss to be spread around is increased. 

Ultimately the entire burden of known debt, hidden debt, false collateral, rotting infrastructure, a banking system with insufficient capital and the biggest of all, unfunded liabilities guaranteed by the government will all fall on the shoulders of the individual taxpayer. That taxpayer is as unaware of his fate as a steer, lying in field, slowly chewing its cud while watching the cattle truck being driven to the corral. 

Wall Street

Are the Wall Street financial markets affected? I do not see how the alphabet soup of financial instruments with and without collateral cannot be part of this situation. The erosion of the pillars of government by underfunding and failure of legislatures to supervise must have consequences. If the legislatures find our regulators resemble capital infrastructure, then they too will suffer the equivalent of deferred maintenance. 

Next

Taxes on capital gains and interest seem likely to be raised. If political expediency outweighs patriotism, then regardless of inflation, recession or depression; temporary tax cuts will be allowed to expire. Such a situation would give tremendous political advantage to incumbents. It would allow incumbents to ‘fix’ the problem in ways that will most benefit them personally. Given the public economic ignorance and disinterest, calculated ‘pot stirring’ in the legislatures will allow incumbents to construct huge re-election chests. The money will pour in from people terrorized by wealth loss and organizations that will pay anything to protect their ox from being gored. That tax burden will add another layer of value loss beyond even that caused by what we know is coming: capital loss due to inflation induced interest rates and profit squeeze. No tax deduction protection will be provided to cover the loss in real value that an investment may suffer due to price inflation. 

Copyright © 2008 Richard K. Brawn
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Richard K. Brawn, CCGA, MPA | Petaluma, CA USA | Email
California Certified General Appraiser (CCGA) | Master Public Administration (MPA)

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