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Facing a Financial Perfect Storm

The once great American Job Creation Machine fully expired in 2008 and finally met its maker. On December 1, 2008, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER)—the private non-profit research organization whose job it is to tell us when recessions start and stop—informed us that the United States officially fell into recession in December 2007, exactly one year earlier. Thus, America’s recession horse has long since left the stable.

This means that, as of January 2009, we are officially in the 2007-2009 national recession, a downturn that now encompasses all or part of three years. The heart of this downturn was the great 2008 job bust. Private-sector employment losses for the year in the United States will, at final accounting, probably total around 2.5 million jobs; 540,000 jobs were lost in November 2008 alone, the largest one month loss since December 1974—34 years earlier. It appears the nation is in a full-metal jacket economic meltdown, with all major components of demand in decline.

There is just no way to sugarcoat the national economic train wreck and it is unlikely that recession conditions of 2009 will be better than that of 2008. At the end of the day, optimists will say this national downturn will remain the 2007-2009 recession—pessimists see it becoming the 2007-2010 recession. In either case, the implications for New Jersey are obvious: the worst is yet to come. The state had very little employment growth momentum when the great global credit crisis fully unfolded in 2008. In fact, between 2003 and 2007, private-sector employment growth in New Jersey (2.6 percent) lagged badly behind that of the nation (7.0 percent). The state’s strong income growth of this period masked this weakness, but it was fueled by unsustainable financial and housing market excesses, both of which are now history. Thus, the state now has to face titanic negative national and global economic forces. The fiscal consequences for New Jersey’s municipalities will be nothing less than traumatic.

Historical Analogies Given this situation, what lies ahead? Since each recession is unique, the past may not be the best guide to the future. However, historical amnesia may cause us to miss important insights. So, let’s take a quick glance in the economic rearview mirror at two historical benchmarks—the last two economic downturns in New Jersey. Lacking the comprehensive national data sets used by the Business Cycle Dating Committee, at the state level we mainly use monthly payroll employment in the attempt to precisely date the state’s recessionary period. Thus, for an individual state, the phrase employment downturn may be somewhat more appropriate than the term recession, but either will probably suffice.

The first benchmark is the severe March 1989-May 1992 employment downturn—265,100 private-sector jobs were lost over 38 months. The second is the milder December 2000-March 2003 downturn—84,800 private-sector jobs were lost over 27 months. As of this writing, the current downturn (December 2007-October 2008) was 10 months long, and 25,000 private-sector jobs had been lost. So, to date (October), New Jersey has not been hit that hard relative to the two preceding downturns. But there will substantial hits to come if the past serves as a prelude to the future.

If the state’s current economic trajectory follows the mild 2000-2003 downturn, which lasted 27 months, New Jersey’s current employment downturn would end in March 2010, and the state would lose an additional 59,800 private-sector jobs. If we follow the more severe 1989-1992 experience, the current employment downturn would end in February 2011, and an additional 240,100 jobs would be lost. Both potential scenarios appear harsh, and they are, but that’s what it means to endure a recession! So, based simply on historical analogy—again, this is not a forecast but simply a repeat of history —the current employment downturn would end between March 2010 and February 2011, and the state would lose between 67,300 and 246,100 additional private-sector jobs (starting November 2008). This is not a pleasant future to look forward to.

The New World Financial Order: Municipal Repercussions The national recession is one of the damaging aftershocks of the greatest lending and borrowing binge in global history. A tsunami of abundant, seemingly risk-free, cheap global credit available at extraordinary low interest rates drove the national and regional economy during the 2000-2006 period. This led to unprecedented wealth on Wall Street—record deals, record profits, record pay, and record bonuses. This was a key engine of regional prosperity during this period. In retrospect, economic gravity was defied, with New Jersey gaining above-average benefits, especially with respect to income gains. But this debt-driven era is over, and unlikely to return.

The five great Wall Street investment banks are no more! Lehman was dissolved, Goldman Sachs and Morgan Stanley became bank holding companies, Merrill Lynch was bought by Bank of America, and Bear Stearns was acquired by JP Morgan Chase. Broad financial-institution de-leveraging and recapitalization are now supplanting what was an unprecedented lending and borrowing binge. Wall Street and the nation’s financial markets are now undergoing a long-term fundamental structural transformation. A new era of lower returns, thinner profits, fewer financial jobs, lower compensation, and more rational bonuses is now emerging. The reverberations of this restructuring are already being felt throughout New Jersey, both through fewer New Jerseyans working on Wall Street and fewer financial sector jobs in the state. And this appears to be just the tip of the financial-restructuring iceberg.

One immediate and direct consequence of this will be evident this year in the state’s Gross Income Tax (GIT), the largest state tax revenue source; 40 percent of the New Jersey’s GIT is paid by the top 1 percent of tax filers. This top 1 percent is closely tied to Wall Street. Thus, New Jersey will take significant fiscal hits in the short term, and diminished expectations long term. The resulting weakened state fiscal position will obviously filter down to New Jersey’s municipalities.

The Era of Consumer Retrenchment The great lending and borrowing binge also underpinned America’s and New Jersey’s home price bubbles, the recent era of prodigious personal spending and consumption, and massive overdosing on plastic credit. But, New Jerseyans now have very little discretionary savings to fall back on as home prices decline, financial markets deteriorate, lending standards tighten, and labor markets weaken. The old adage “When the going gets tough, the tough go shopping” is now history. A new era of consumer retrenchment is upon us. Just like financial institutions, households must deleverage and recapitalize. Thus, shopping will be in retreat. This has very significant negative implications for state sales tax revenues, the second largest state tax revenue source.

Other Problems A third problem is also directly linked to the new world financial order. Abundant cheap global credit, not underlying market fundamentals, made many real estate, housing and development projects possible that simply were not possible before the 2000-2006 period. But the era of severely under-priced risk is now history. The return to rational lending standards will make many projects impossible again, inhibiting the growth of nonresidential ratables. Commercial real estate will also have to confront the classic “over and under” problem in 2009 and 2010: over-built, over-leveraged, and under-leased. The existing available inventory —and that in the pipeline—is more than sufficient to cover additional demand. Thus, it will take a considerable amount of time for full market absorption and will involve a considerable amount of pain. Growth in commercial real estate ratables will certainly not be an engine of municipal fiscal growth for the foreseeable future. The same is true of residential ratables, since the painful housing market correction is probably just in the fifth inning.

The confluence of events depicted above suggests the perfect fiscal storm has aligned for New Jersey’s municipalities. A drastically weakened state fiscal position has ominous implications for municipal support while property tax revenues are simultaneously under assault. The municipal fiscal business protocols of the past have reached full obsolesence and changes are inevitable and necessary.


Authors: James W. Hughes and Joseph J. Seneca of the Edward J. Bloustein School of Planning and Public Policy at Rutgers University.

Published in New Jersey Municipalities, Volume 86, No. 2, February 2009.


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