This guest commentary was written by Christopher Whalen. It was originally posted on The Institutional Risk Analyst. This piece does not necessarily reflect the opinion of Hedgeye.
In this issue of The Institutional Risk Analyst, we return to the fiscal situation facing New York and other major American cities in the wake of the apparent victory by Vice President Joe Biden in the 2020 Presidential election.
The weak showing by the Democrats has stymied much of the promised Biden agenda, particularly trillions of dollars in aid to large cities in blue states that was seen as a given only weeks ago.
The situation facing New York is perhaps worse than that facing other cities, both because the government of Mayor Bill DeBlasio already had a spending problem as 2020 began and because the impact of COVID on New York is more severe. The extended lockdown imposed by Mayor DeBlasio and Governor Andrew Cuomo caused roughly half a million people to leave New York City between April and the end of July, according to the New York Times. This figure has increased since July and does not include the disappearance of tourists and other visitors from the streets of New York. And most of midtown Manhattan remains boarded up due to fears of rioting and looting.
The grim reality facing New York is summarized in the most recent annual report for the fiscal year ended June 30th from New York Comptroller Scott Stringer, who was formerly the President of the Borough of Manhattan. New York City is one of the best managed US cities in terms of financial reporting, but less so when it comes to spending and fiscal sanity. Under the free spending Mayor DeBlasio, the city has seen revenues rise by high single digits each year and expenses have more than kept pace.
In FY 2020, New York City had revenue of $95 billion and expenses of almost $99.5 billion. The details of the NYC budget are shown below from the FY 2020 annual report.
Note that NYC has an accumulated deficit of over $200 billion and total long-term debt and other obligations of $270 billion. And these figures do not begin to capture the total debt and other obligations buried in the city’s over-extended financial statements.
Keep in mind that the revenue numbers for NYC through June reflect the strong momentum of the city coming into 2020 and only begin to show the deterioration in the revenue of New York City since the start of FY 2021 on July 1st.
Several sources have talked about a fiscal deficit of $8 billion in 2021, but we think the actual deficit number could be twice that or more. The chart below shows the city’s cash balance through June 30 (blue line) and then the estimate from Comptroller Stringer’s office.
Notice that the estimated cash line from FY 2020 crosses through the cash line for FY 2019 in September and has trended below last year’s results since then. The estimates from Stringer’s office show cash balances falling below $2 billion around year end, then miraculously rising as the result of a Biden financial rescue plan. The FY 2020 annual report for NYC was finalized weeks before the Presidential election.
But now that the election has ended with the closest race in a century and has seen the GOP pick up seats in Congress, the Democratic calculous that assumed a financial rescue by Washington needs to be reassessed. If there is no fiscal rescue plan for the states and particularly the large cities in blue states like New York, then it seems safe to predict that several large American cities may be forced into default before Joe Biden takes the oath of office in January.
“Big city mayors and Democratic state governors had been counting on a ‘blue sweep’ of national offices to help get them out of some very deep budget and pension funding holes. They also dreamt of green transport, more help with healthcare . . . the list was long,” writes John Dizard in the Financial Times.
“Now there is the grim winter reality of a surviving Senate Republican majority, led by Democratic bugaboo Mitch McConnell, which keeps its veto on all that progressive spending and redistributive taxation.”
Of course, Republicans in Congress have no intention of riding to the rescue of the blue states. Changing the state and local property tax (SALT) deduction was the first assault on the economic base of the Democratic Party. Step two is to push major cities like New York into bankruptcy, which would force a violent confrontation with the public sector unions. Such an apocalypse would see elected Democrats voiding union contracts and also see the end of New York’s New Deal era state constitution.
Red-state Democrats in Congress are unlikely to be very enthusiastic for spending trillions of dollars to help New York City, thus Congressional Democrats have a serious problem brewing in New York and cities like Chicago. The Stringer report is quite a sobering read, particularly as it details the impact of COVID on the New York economy. For example:
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In New York City, employment plunged by almost 20% from February to April and grew by a smaller 3.2% from April to June. This nearly 20% decline in New York City employment was equivalent to the loss of an unprecedented 910,050 jobs between February and April.
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Small business revenues declined dramatically in March. Manhattan small business revenue was already declining in early March, and had declined by 70% by month’s end, as businesses shuttered and commuters stayed home. Despite some recovery, Manhattan small business revenue in early July was still down over 40% from the beginning of January.
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Most immediately, a failure by the Federal government to provide adequate fiscal relief to state and local governments could upend the New York State budget—and by extension, the City’s resources. New York State has threatened to reduce local aid by as much as 20% if Congress does not appropriate additional unrestricted aid to state and local governments, using executive powers included in the enacted State budget.
The big problem for New York and other major cities like Chicago and Los Angeles is that the dollar of municipal revenue comes from many different sources. When the local economy is disrupted massively as in the case of New York and other blue state cities with restive populations, the impact on the different components of city revenue is magnified. The breakdown of NYC revenue for the last fiscal year is shown below.
The real question facing NYC is how much will the impact of COVID and the exodus from the city due to fears of rioting and looting impact each of these revenue lines. Sales and use taxes are clearly down, and real estate taxes are also falling as more tenants and landlords default. Surviving landlords will press the city for reductions in appraisals and taxes.
Last month, New York City and state both had their credit ratings lowered by Moody’s Investors Service, which said the impact from the coronavirus on the most populous U.S. city -- the core of the state’s economic engine -- is among the most severe in the nation.
“In a pair of downgrades announced within an hour of each other, Moody’s dropped both the city and state by one notch to Aa2, the third-highest investment grade rating,” Bloomberg reports.
But frankly neither issuer deserves an investment grade rating at this stage. With Mayor DeBlasio refusing to take action to cut city expenses to size with the new population of Gotham, and Governor Cuomo suddenly sounding like a Republican deficit hawk from the 1990s, a default seems inevitable.
The FY Q1 2021 numbers ending September 30th won’t be released until December, but suffice to say that the picture is likely to be a good bit more dire by that time. Comptroller Stringer proudly notes in the FY 2020 annual report that the city has not had to issue short-term cash notes for 16 consecutive years.
When you see New York City issuing cash notes, that’s your hint that a debt default by America’s largest city is imminent. Truth is, it's already too late. Mayor DeBlasio cannot cut spending fast enough now to avoid running out of cash.
Will Senator Mitch McConnell (R-KY) and Senate Republicans really push New York into default? Yeah, they probably will and more. Students of history will note the mirrored parallel between Biden and President Herbert Hoover, who FDR declined to help in 1932 as the nation's banks were collapsing.
President Donald Trump will be cheering on Senate Republicans as he heads home not to New York City but to Palm Beach. For investors in municipal credit, the next couple of months will be quite an experience.
ABOUT CHRISTOPHER WHALEN
Christopher Whalen is the author of the book Ford Men and chairman of Whalen Global Advisors. Over the past three decades, he has worked for financial firms including Bear, Stearns & Co., Prudential Securities, Tangent Capital Partners and Carrington.
This piece does not necessarily reflect the opinion of Hedgeye.
