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When the housing “crisis” meets a financial crisis, who will pick up the tab?
The Governor of California recently signed a slew of housing incentive laws, designed to wrest control of planning, zoning, and project permitting approval away from locally elected governments by imposing top-down, state-mandated control. These laws will add significant infrastructure cost burdens on local taxpayers, to accommodate the growth being incentivized. These laws also remove many environmental protections and in some cases completely eliminate existing public-process protections under the now tattered California Environmental Quality Act.
As explained in recent Marin Post articles, the premise that supports these dramatic changes is based on faulty and politically motivated “need analysis,” not demonstrable facts. And, the end of this appears to be nowhere in sight.
The political and financial interests that are backing this momentum to urbanize suburbia and super-urbanize our cities have a long wish-list of additional legislative proposals that we’ll be seeing in 2020.
Perhaps, the most worrisome among these new laws is AB 1487 (Chiu), which established the Bay Area Housing Finance Authority (BAHFA); a new regional agency run by politically appointed board, chosen, primarily, by the unelected Metropolitan Transportation Commission (MTC).
The Authority’s purported goal is to address the San Francisco Bay area’s housing affordability crisis. However, this new agency was created without any affordable housing goals or mandates, other than a belief that affordability will somehow automatically result from an overly simplistic understanding of how supply and demand and markets work.
The last time we put our faith in the belief that markets solve everything, when it comes to producing affordable housing, was under the Reagan Administration. How did that work out?
Regardless, BAHFA’s powers now include the power to raise, administer, and allocate funds regionally.[1] They can unilaterally issue public debt (putting bond measures on the ballot), levy “taxes” and “fees” (a form of “taxes” disguised as service fees) on homes, businesses, automobile travel miles, parcels of land, real estate transactions of all types, and pretty much anything else they want.
None of these revenue generating ideas, by the way, are new. MTC has been promoting them since Plan Bay Area was first announced in 2013. Now, they finally have the unfettered powers they've wanted.
A closer look
In my last post, I examined the increasingly important role that financial markets now play in the future financial health of our city, counties, public and private employee pension funds, and our state government’s solvency.
The purpose of the analysis presented in this article is to alert readers to the level of risk they are now being volunteered for, without their knowledge, and to suggest that this suite of new laws potentially poses a very real threat to our shared financial well-being.
This analysis contemplates what could (will) happen when (not if) we experience a major economic downturn and recession, and how the impacts of these new laws indicate that most, if not all, of the financial liability of the initiatives and projects, now promoted by BAHFA, will be shouldered by San Francisco Bay Area residents and taxpayers.
As I’ve said before, if you’re playing poker and you don’t know who that patsy is at the table, you’re the patsy.
The financial health of the “patsy”
Today, our economy and the financial markets are dangerously dependent on increasing consumption, at a time when the demographics indicate consumption will likely decrease, because baby boomers are retiring and younger generations appear much less consumption oriented. This means that even in the best of times over-dependence on consumerism would be ill-advised. But we need to add to that the currently poor financial health of the average American family.
Americans of all ages, generally, have too much debt. And there are warning signs that the type of debt is, again, getting sketchy. By this, I’m referring to “cash-out” home equity loans and lines of credit. As you can see in the chart below, these high risk loans are perilously close to the levels seen only once before, before the real estate crash of 2008.
Courtesy of Freddie Mac
What the chart shows is that more and more people are pulling out cash against the appraised value of their homes, in order to continue to maintain lifestyles they cannot afford. And this time around, it doesn’t appear that what they are spending that money on is frivolous, as much of it was in 2008 (like flipping homes). Now it’s more often being spent on food, education, healthcare, and other essentials.
However, at the same time, as we also saw in 2008, the federal government has again dramatically expanded exposure to risky mortgages. So the game goes on and this federal “put” further emboldens the equity and debt markets.
Corporations are not doing much better… or maybe they are doing in on purpose
This chart shows the relationship of U.S. non-financial corporation debt to the Gross Domestic Product from 1962 to 2018. It’s now at about 75 percent of GDP—the highest in history.
Courtesy the Bank for International Settlements
Similar to consumers, corporations are falling deeper and deeper in debt, but in their case they are doing it eagerly even if they don’t need the funds. Capital investment by U.S. corporations (what they should be spending that borrowed money on) has been falling steadily over the same time period. So, where in the money going?
The answer is that a greater and greater percentage of the money corporations are borrowing has not been invested in their operations or their employees, but instead has been increasingly spent on executive compensation and benefits, and on buying back their own stock shares (to decrease the public “float”), to artificially goose up share prices – which, of course, are directly tied to most executive compensation.[2]
So, if the balance sheets of both consumers and corporations are looking historically worse, why are the public markets still soaring?
Our “robust” public markets
As I noted in the first article, the health of the nation’s stock markets and debt (bond) markets is suspect at best. One of the most reliable signs of what former Fed Chairman Greenspan called irrational exuberance, is how market participants are using borrowed money (called “margin debt”) to continue to buy more and more shares (driving prices higher).
The chart below shows the relationship of the S&P 500 value and the amount of margin debt in the markets. This is definitely not a reassuring picture.
Courtesy of Advisor Perspectives
This chart shows a negative divergence, meaning two trends going in opposite directions in a bad way. And in this case, an extreme divergence. Rising stock prices are directly correlating with increases in margin debt. No one knows when or how this divergence will correct itself.
There is little doubt that interest rates, which are being kept artificially low by the Federal Reserve, are throwing gas on this fire. With money being almost free, why not borrow big and bet on the ponies… even if only for a day trade... or a milli-second trade?
The general mood of professional money managers these days—the guys who are overseeing your 401Ks and mutual funds—has gotten so complacent that a financial pundit at thestreet.com recently commented,
“…the mighty Apple (AAPL) is holding up and seems to function as a de facto money market account these days. It is a great place for some to park cash and that helps to keep the indices hovering near highs.”
In other words, "Full speed ahead, no icebergs anywhere on the horizon, captain."
Meanwhile, back at the ranch
Bringing this conversation full circle, there is no question that the BAHFA intends to aggressively use their powers, noted above, to raise funding to promote massive regional growth and development, even if it is undecided at this time which methods and in what priority they undertake their projects and initiatives.
However, what is not considered in the law is that once the agency has levied those taxes and fees on a wide variety of possible transactions, private revenues, and assets, and has pledged the commitment of those tax and fee and bond revenues to a variety of actual, brick and mortar real estate development projects,[3] what happens when a downturn comes and many of those real estate development projects fail?
Who will be left holding the bag to cover financial shortfalls and losses?
History has shown us that there is always a high failure rate in real estate development in economic downturns.
You’ll read a lot in the press, lately, about how optimistic sentiment among CEOs of large residential building companies is rising. This is wishful thinking.
Consider this chart.
Courtesy of Advisor Perspectives
The cold hard facts are that housing starts are lower than they’ve ever been since just after World War II, when adjusted for population growth. And this chart shows it’s a national phenomenon, not a uniquely California problem. It's true in every state and every area: urban, suburban, and rural. Builders are just not building anywhere because people cannot afford to buy regardless of the market they live in. And this is with mortgage interest rates at historic lows. Consider for a moment what that implies about this country's financial health.
This one chart debunks the entire premise that AB 1487 and BAHFA are built upon. If there were buyers out there, builders would be building to satisfy the real demand.
The failure of representative government to "represent"
There is no question that government should be doing something to incentivize more affordable housing. There are many solutions that could be pursued that are practical and available to immediately bring significant investment to the housing sector, without the need for yet another gigantic bureaucracy. I've been writing about those and met with representatives about it for years, to no avail.
The California political machine is hellbent on centralized, top-down, iron-fisted control. Both of our state representatives (Assembly member Levine and Senator McGuire) enthusiastically supported AB 1487. In doing so, they have carelessly allowed an unelected “transportation” agency (MTC) to become a regional real estate investment powerhouse, overnight, without MTC having any demonstrable expertise or real world experience, and they've left taxpayers holding the bag if (when) their grandiose visions fail.
I’ve been involved in the development business, in one way or another, for 50 years as an architect, contractor, developer, and investor. And in that time, I’ve been through many market cycles. Private developers are a hundred times smarter about the pitfalls of market cycles, finance, and the development business than government agencies, and still there are no shortage of examples of how even they’ve gotten it wrong and failed.
But now we’re supposed to believe that BAHFA will somehow do it better?
Historically, every time the government has relieved private development interests of the financial risks and consequences of failure (and substituted "other people's money" -- taxpayers') it has led to abuse, bankruptcies, and political corruption.
What MTC and vested development interests have done is to finally find a way to resurrect the discredited housing redevelopment agencies that were dissolved by the California Supreme Court in 2013 for being hotbeds of political favoritism and corruption.
If (when) BAHFA-backed projects fail in the next recession, what happens to the cities and counties that have taxed and assessed residents and businesses to build out infrastructure (water, sewer, and power services, roads and everything else) to support BHFA-backed developments that never come to fruition?
Who will take over the bond payment obligations for the "project-based" debt financing that paid for the development of the project or infrastructure, which were backed by the city’s, county's or the state's general fund obligations… those same general funds that have already been pledged to pay for unfunded pension liabilities, which, by the way, will be in their own crisis at the exact same time?
When a project is in default, if a government entity's choice (local, county, regional or state) is to declare bankruptcy or to pile more taxes and fees on the backs of taxpayers, to address revenue shortfalls, which choice do you think they will make?
If this all sounds too alarmist, perhaps, you’d like to bet on it? Oh, I forgot, Sacramento already did, with our tax dollars.
[1] AB 1487 authorizes the BAHFA “to impose various special taxes, including a parcel tax, certain business taxes, and a transactions and use tax… and to issue bonds, including revenue bonds” and “to impose a commercial linkage fee on businesses, …and require a city or county in the San Francisco Bay area that has jurisdiction over the approval of a commercial development project to collect that fee as a condition of that approval and remit the amount of fee to the entity.”
[2] Corporate stock buybacks became illegal after the Crash of 1929, and were not reinstated until the Reagan Administration in 1982.
[3] BAHFA’s powers include “delivering resources and technical assistance at a regional scale, including …assembling parcels and acquiring land for the purpose of building affordable housing.”
READ PART ONE - The Dow Jones, CalPERS, and Us
READ PART THREE - Party on to the Apocalypse
READ PART FOUR - What Now?
Bob Silvestri is a Mill Valley resident and the founder and president of Community Venture Partners, a 501(c)(3) nonprofit community organization funded only by individuals in Marin and the San Francisco Bay Area. Please consider DONATING TO CVP to enable us to continue to work on behalf of Marin residents.