12/16/13 - an unexpected boon to the middle states

In today's selection -- from famed Wall Street forecaster Meredith Whitney in her new book Fate of the States. Although the trend of the last few decades has been the movement of people and wealth to the East and West coasts, the debt accumulation that led to the Great Recession has given a surprising recent advantage to states in the middle of the country:

"The deeper I dug into the latest economic data, [the more] it became clear that there were some regions of the country so burdened with debt that a muscular rebound in consumer spending would be virtually impossible. California, Florida, Arizona, Nevada, Illinois, and New Jersey had some of the most highly indebted residents in the country -- which I knew because I tracked the banks' geographic lending concentrations. During the housing bubble, banks had targeted these areas for their hot real-estate markets and for rising personal income levels. When the bubble finally burst, these states wound up with the nation's highest levels of negative equity (i.e., owing more on your mortgage than your house is worth) as well as some of the highest unemployment rates. They were also where banks had cut back credit lines most dramatically. Anyone in these areas living paycheck to paycheck had gotten a sobering margin call over the past few years. Without equity to borrow against -- a key source of funding for small businesses -- new-business creation, along with new-business job creation, plummeted and unemployment soared. Choked off from credit, consumers cut back on spending, digging the economic hole even deeper.

"The recovery in those states would be plodding at best. But the story was very different in the states that had never been targeted by the banks during the boom years. In the central corridor of the country -- sometimes referred to as the 'flyover' states -- the boom years were less exuberant. In Ames, Iowa, for instance, home prices went up a mere 5 percent in 2005, compared with 20 percent in Jacksonville and 41 percent in Phoenix. Banks weren't offering folks in Iowa or Texas unlimited access to credit, and thus homeowners never got in over their heads. Because housing didn't boom, it didn't bust there either. Consumer spending was more closely correlated with employment and wage growth than with availability of credit. Since jobs in the central corridor weren't dependent upon housing, these states didn't see huge spikes in unemployment after the bust. What's more, manufacturing jobs are now coming back to these areas in a big way, as more and more companies locate there to take advantage of less expensive real estate and incredibly cheap and plentiful U.S. energy.

But there was something else I discovered that made these flyover states so attractive to employers and job seekers. Their state and local governments hadn't piled on scads of debt during the boom times. As a result, there was no pressure to hike tax rates. And because they didn't have crippling debts, they had money to invest in education, roads, airports, job training, and other public services. To be sure, energy production is a big part of the story in some locales. There's no doubt, for example, that North Dakota's oil patch would still be booming even if, back in the 2000s, there'd been a housing bubble on the prairie. Nevertheless, more companies were starting to pay close attention to which states offered the lowest tax rates, boasted the best and most sustainable infrastructure, and were the most pro-business as measured by right-to-work laws and workers' compensation rules. Since 2008 these central corridor states have had unemployment rates well below the national average, as well as rising consumer spending and robust tax receipts -- the exact opposite of what's happened in the housing-bust states.

"Talk about a shocking reversal of fortunes. California, New Jersey, and Illinois were economic powerhouses. Post-recession, not only are their citizens eyeball deep in debt, but their state and local governments are awash in red ink too. Today these states can't help but have outsized tax rates because their government budgets are so out of control. They've been forced to cut deeply into education, infrastructure, and other public services. And in an unhappy coincidence, these states also happen to be three of the most politically and bureaucratically grid locked in the nation, making reform incredibly difficult. California, notoriously unfriendly to business, raised the marginal state tax rate on those making over $250,000 to the highest rate in the country in 2012. The result: a rush to the door by many of those high earners. In 2011, Illinois hiked its income tax rates by 66 percent. The governor was then forced to try to strike side deals with large businesses that threatened to leave the state. Even after the tax hikes, these states still have enormous budget gaps that require even deeper cuts to education and other public services. State and local government spending cuts combined with severely weakened consumers don't exactly help the job market either. Unemployment in these former boom states has been consistently above the national average since 2008.

"Last decade's housing boom and bust may have been a national story, but until I pored through the numbers, I didn't realize how distinctively local some of the fallout truly was."


Meredith Whitney


Fate of the States




Copyright 2013 by Meredith Whitney


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