Taking Stock of Bonds

February 11, 2008

The Financial Ecosystem

In assigning an ‘AA’ rating to New York City general obligation bonds on Monday, Standard & Poor's pointed out that The Big Apple revised tax revenues down by $261 million and noted that weakness in the financial services sector is expected to affect tax collections, real estate transactions and overall consumer spending.

The city "has requested spending reduction programs from city agencies equal to 2.5% for fiscal 2008 and 5.0% for fiscal 2009," says S&P.

While New Yorkers like to think they are special and that the world begins and ends with the Hudson and Harlem Rivers, the drop in tax revenue because of problems on Wall Street probably are not unique to the city. Lower tax collections likely will be felt in other cities, large and small. They may not all be directly tied to Wall Street layoffs, but the drain in liquidity and drop in lending in lower Manhattan has made its way across the US. Call it the financial version of Sherman's March to the Sea.

How Manhattan weathers the downturn is yet to be seen. For now, it may be able to raise taxes. But the question is what happens to the smaller local government that cannot bear the loss of income? Wall Street's great income generation machine kept alive consumer spending and many industries. So, what happens to municipalities that lose employers -- homebuilders and mortgage lenders -- because of the credit downturn?

Such a loss means that local treasurers no longer get tax income from their local business and they see a drop in tax income from residents who lose their jobs. If the economic downturn proves to be as bad as some expect, the lockup in Wall Street's credit machine means consumer spending will drop enough to impact a broad range of "mini-economies" that were nursed by free-spending consumers.

What happens when local governments face a shortfall in their treasuries? As S&P notes in its review of New York City, they cut back on services, and this then can impact the quality of life in a community, changing how people view their cities and towns. Eventually, they can become less desirable places to live, contributing to a further erosion of home values.

It may not be much of a leap to see the US economy as an ecosystem. When one aspect of that web of economic interaction is scrambled, it is sure to impact other members of the economy.