Financial History Issue 117 (Spring 2016) | Page 27
Cities and States Were in Dire Straits
Before They Had Pension Obligations
By Frederick J. Sheehan Jr.
Current worries about municipal solvency focus on pension plan liabilities,
with a widely-held belief that if pension problems could be solved, then so
too would the troubles of state and city
finance. This is a leap of faith. Even if all
pension obligations disappeared, financial
problems of states, cities and towns would
run deep. A review of municipal insolvency in the 1930s — a time when pension
obligations were in their infancy — shows
how municipal policies designed in good
times may turn sour.
The solvency of cities and states looked
assured in 1929, at least according to
Moody’s. That year, the agency rated all of
the nation’s 25 largest cities Aaa. This was
also true for 46 of the 48 states, as well. Yet,
in 1932, many of the cities could not sell a
bond at any price, and their bonds did not
trade. By 1935, at least 3,252 municipalities
were in default.
It is an oversimplification to look for
a single culprit, but it may be true that if
real estate speculation had not run wild,
the 1930s would have been different. There
is a history of real estate splurges leading
to municipal busts. H.C. Adams wrote
in 1887: “The mention of the words ‘real
estate’ suggests…a reason why ambitious
cities are so willing to incur heavy indebtedness… [T]he bonding of a town, and
the expenditure of the money procured in
showy works, is the occasion of actual gain
to those who speculate in real estate…”
Adams found the “showy works” made
the city more attractive, increased property prices and produced more revenue.
His observation was held out as a truism
in the 1930s. The thousands of showy new
schools and athletic facilities being built
today offer room for reflection.
A.M. Hillhouse, in his study of municipal bond defaults in the United States,
resurrected Adams. In his 1936 book,
Municipal Bonds: A Century of Experience, Hillhouse assessed “the major portion of overbonding by municipalities
arises out of real estate booms.” Hillhouse does not dismiss the stock market
crash, the production boom, the spending
splurge or widespread access to credit by
consumers. Rather, he draws his conclusion of the common thread after studying
defaults back to 1836. Likewise, there are
many other lines of activities that must be
addressed to gather a full understanding
of what must be corrected today.
Residential real estate topped out
in 1925, and commercial building was
favored into the early 1930s. The supply of
returning soldiers after World War I and
the reduction of residential building during the war created a demand for housing.
Potential builders were reluctant to fill the
void, since construction costs more than
doubled after 1914. During that period,
apartment rents had not risen. Between
1918 and 1920, residential rents increased
by 65% and building costs fell 25%. A
nationwide housing boom commenced.
By mid-decade, the balance of building
to potential occupants had been restored.
Residential real estate then grew speculative and laid waste to municipal budgets
by the 1930s.
There was a forerunner. Municipal
insolvency already filled the Florida courtrooms by the late-1920s. This might have
served as a warning elsewhere. Maybe
it looked too fantastic to be believed. In
any case, because the Florida land bubble
distorted behavior and finance to such
a degree, it shows how Adams’s claim
in 1887 applied in 1932. Parallels to postmillennium excesses are also evident.
Property valuations in Miami rose
over 1,000% from 1918 to 1923. Promoters
descended on the state. Restaurants and
delis in Miami served lines of speculators
coffee for 75 cents (with no cream) when the
going price for a cup in New York City was
a nickel. In the summer of 1925, residents of
Miami placed “Not for Sale” signs to ward
off the pests. Leases to realtors reached $700
a square foot on Flagler Street in Miami,
when similar space at Broadway and 42nd
Street in New York — a very desirable location — rented for $13 a square foot.
Coral Gables was born in 1921 and posted
over $100 million in property sales in 1925.
Miami real estate transfers increased in
volume from 4,126 in January 1924 to 9,744
in January 1925 to 16,960 in October 1925.
Florida was hit with a 125 mile-per-hour
hurricane in 1926, and Miami’s real estate
transfers fell to 4,491 in October 1926.
The realtors and speculators were gone,
as was the municipal revenue attached
to their fevered activity. Florida was now
stuck with high fixed costs that were not
easily remedied. (To meet the swirl of
activity, Miami’s municipal payroll had
risen 2,500% between 1921 and 1925.)
Paul S. George wrote in “Brokers, Binders, and Builders: Greater Miami’s Boom of
the 1920s,” that “the amount of individual
and corporate financial ruin resulting from
its collapse is incalculable.” Incalculable, but
easy enough to project into the 1930s, when
so many tentacles that had boosted municipal revenues — the very sources that had
been projected to spend ever more freely
and absorb rising public costs — vanished.
George continued, “This speculative
era also led many municipalities to institute costly internal improvement programs that were financed by bonds.” Coral
Gables was saddled with $29 million in
creditor claims by 1929.
A common pattern across many cities
was for the post-World War I housing
deficiency to abate, but for a residue of
speculation to weigh heavily on municipal coffers and on the banks holding title
to abandoned property. The residential
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