The Crisis in Real Estate and Its Impact in Public Finance - Summary - September 24, 2010

Conference Looks at Current Real Estate Market and Government Finance

On September 24, the Federal Reserve Bank of Atlanta's Center for Real Estate Analytics sponsored a conference titled "The Crisis in Real Estate and Its Impact in Public Finance." The conference brought together academics, policymakers, and practitioners to discuss the difficulties for state and local government finance that the current real estate market poses.

Session 1 of the conference, "The Housing Crisis and Local Revenues," featured two presentations that focused on the accounting arithmetic behind the revenue shortfalls in state and local governments. Both presentations—one by Byron Lutz, Raven Molloy, and Hui Shan of the Board of Governors of the Federal Reserve System, the other by Keith Ihlanfeldt and William Doerner, both of Florida State University—reached very similar conclusions. They found that the current shortfall in revenue is largely attributable to the economic recession and not to the decline in home values that are tied to the property tax receipts on which many state and local governments depend. That is, the recession lowered income tax and sales tax revenues, negatively impacting state budgets, and that effect outweighs the impact of the decline in real estate prices and real estate- and construction-related activity. This finding is not particularly good news. The effect of real estate price declines on property tax revenues is only just beginning to be felt. Property taxes are based on assessed valuations that are inherently backward looking. The process of reappraising property in the face of declining values takes some time, so the full impact of the decline in real estate prices is unlikely to be felt by local governments for another few years.

Session 2, "Real Estate and the Pension Problem," examined the consequence of the decline in real estate values on state and local government pension funds—an issue largely ignored in current discussions of the fallout from real estate. Both presenters—Joseph Pagliari, clinical professor of real estate at the University of Chicago's Booth School of Business, and Michael Acton, managing director of EW Capital Management—pointed out that state and local government pensions are often underfunded, and the funding that has been provided has, in part, ended up being invested in commercial real estate, with results that are not particularly pretty. Commercial real estate loans made during the peak of the market are now coming due and will be problematic for the foreseeable future.

The luncheon speech (Session 3) featured Michael Pagano, dean of the College of Urban Planning and Public Affairs and interim dean of the College of Business Administration at the University of Illinois Chicago. Pagano, who has co-authored work for the National League of Cities, presented his paper titled " 'Painting the Town Red': Cities' Fiscal Position as if It Were 1935." Pagano explained that since many people describe the current economic situation as the worst recession since the Great Depression, he felt it would be very useful to go back and compare the current fiscal positions of cities with those of cities during the Great Depression, when 4,770 municipalities defaulted on their debts. Pagano's paper was perhaps the most encouraging one at the conference, if only because he made it clear that cities' fiscal positions now are clearly not nearly as bad as they were during the Great Depression.

The conference concluded after lunch with a panel specific to the state of Georgia, titled "Rethinking Tax Revenue: The Georgia Case." Discussion started with Carolyn Bordeaux, associate professor at the Financial Research Center of the Andrew Young School of Policy Studies at Georgia State University and former director of the Georgia Senate Budget Evaluation Office. She presented an outlook for Georgia's budget, focusing primarily on the structural nature of the current deficit. Up next was David Sjoquist, director of the Fiscal Research Center and the Dan Sweat Distinguished Chair in Educational and Community Policy at Georgia State's Andrew Young school of Policy Studies. Sjoquist is a member of the Georgia Tax Reform Council, which holds a unique role in state tax reform processes and which may ultimately serve as a model for other states dealing with the sensitive issue of tax reform. Sjoquist's presentation focused on potential changes in George's tax structure, particularly as they relate to how the code as it currently exists was really established for an economy of several decades ago. Spending and consumption patterns have changed dramatically since the tax structure was initially put in place. Sjoquist suggested several ways the tax structure can be brought more into line with the economy of today.

This first conference sponsored by the Center for Real Estate Analytics has begun to address some of the crucial issues regarding the interplay between real estate markets and state local governments. These are issues that will be confronting all state and local governmental units for years to come.