In a Bad State

This has dire portents for regional banks, which hold 70% of bank-held commercial mortgages. It also signals rough times ahead for city and state budgets, which rely on taxes on office buildings that are about to fall in value.

What happens when the federal money runs out and cities and states have to tighten their belts? That’s one of the main questions considered by David Schleicher, Yale Law Professor and author of “In a Bad State: Responding to State and Local Budget Crises,” whom I interview on the podcast this week. City and state budgets have been flush since 2020, when the federal government sent out billions in aid packages. But that money is, in many cases, being clawed back, spent, or has already been committed to new programs.

“When you have to bailout a city or state, you’re left with three choices,” David says. “I call it a trilemma. One, you can bail them out with federal money. The problem is that everyone thinks that cities and states that get into trouble will get bailed out, which leads to bad behavior both from politicians who will continue to overspend and lenders who give them access to money. Two, you can choose austerity. The problem there is that you will cut workers and services, generally when things are already going badly, which makes a bad time worse. Three, you can default on the debt. This raises the cost of lending to cities and states, who build virtually all of our infrastructure.”

“In our history, we’ve done all three,” David comments. His book details how the US has handled local budget crises in the past, from Hamilton assuming state debts in the 1830s to Detroit’s managed bankruptcy and Puerto Rico today. His argument is that there are ways to mitigate the downsides of each of these approaches with elements like conditional aid that push more responsible accounting and behavior. “If each approach has a major problem, you can do a little of each: a little bailout, a little austerity, a little default.” He uses Detroit as an example, where there was a bankruptcy but also state and philanthropic aid immediately afterwards.

David cautions that states and cities are often set up to be vulnerable fiscally by what he describes as their ‘broken politics.’ “The central problem of state and local politics is that they lack functional popular politics. Most voters know little and care less about state politics, with state elections outside of gubernatorial races largely serving as referenda on the president of the United States. The lack of broad public engagement with state politics leaves state and local politicians in hock to the narrow set of voters and lobbying groups who dominate low-information elections like legislative primaries or off-cycle local elections . . . state and local officials do not seek, and do not receive, a public mandate from ordinary voters. They are instead responsive to narrow and unrepresentative groups of voters and interests.”

Basically, local politicians have to listen to special interests because they're the only ones paying attention. That leads to financial precarity over time. Who would make a tough call for the public good that antagonizes a powerful interest group?

As David put it in his recent piece in the Atlantic, “We have ignored state and local politics, assuming that everything will work out fine. Once federal cash stops flowing and budgets worsen, the costs of having done so will be all too clear. Whether and how we respond are up to us.”

Sounds like a challenge worth responding to.

Want to improve local politics? Check out Forward in your state! For my interview with David click here.