State tax revenues are likely to stabilize in the spring or summer after more than a year of record deep decline. This stabilization will still leave half of the states with declining revenues and almost all of the states with meager reserves. The fiscal situation is generally worse for municipal governments and schools and special purpose government units. They rely heavily on property tax receipts which hold up longer into a recession and then decline well into the recovery. This is because of the long lag between a change in economic conditions and property assessments and then another lag between assessments and collections. However, many well managed local governments and school and special districts are financially able to continue with pre-recession spending plans.

The extent of construction cutbacks will not be known until state budgets are finalized. In spite of constitutional requirements that budgets be finalized before July 1st, many states will take months longer to complete this ugly process. In both the current and previous fiscal years, most states have had to make interim cuts after the initial budget approval to accommodate tax collections below the budgeted level. Some states will be in the same position in the next fiscal year but many states will collect more taxes than expected in an expanding economy and be able to restore some previously cut spending.

Spending cuts will not be enough to avoid bankruptcy in some municipalities. Municipal bond defaults total $6 Billion in the last ten months. Most of these were for revenue bonds without the guarantee of tax revenue to cover bond payments. Some of the defaults were covered by bond insurance. But very few of the recent municipal bonds have bond insurance because many of these insurers were bankrupted in the subprime mortgage crisis. Expect more bond ratings to be lowered, raising costs and stopping some projects.

Chapter 9 municipal bankruptcy is now being openly discussed in Harrisburg PA and in Detroit. Massive cost overruns on an incinerator upgrade are the problem in Harrisburg. Two bond payments have already been missed and covered by the bond insurer. Detroit’s problem is that more than a quarter of its housing units are vacant, sharply reducing tax revenues. The Mayor of Los Angeles has stated that bankruptcy may be inevitable. This list of troubled cities will get longer.

The municipal fiscal crisis is the consequence of the consequence of the deepest drop in tax receipts in more than 50 years plus, in some cities, unsustainable spending for staff cost — wages, healthcare and pensions. Vallejo California (between San Francisco and Sacramento) is now in Chapter 9 due to plunging tax receipts and soaring staff costs. Their bankruptcy sours their access to capital for many years until investors see not just a change in their balance sheet but an improvement in their financial management.

There is now a high risk of a bankruptcy of a major city. This would have a depressing impact on municipal access to capital for several years.