kiplinger connection
The States • Federal Reserve • Mortgage Fallout

The States: Look for widespread privatization of state projects.
Federal Reserve: Fear of the unknown is driving the credit crunch.
Mortgage Fallout: Municipal bonds are feeling the stress too.

The States
As more state budgets are squeezed ... half already face sudden revenue shortfalls due to the slump in housing and sales taxes ...
Privatization projects are soaring.
They’re a quick source of needed cash and a long-term hope for capping worker costs.
That’s good news for many businesses that can nab new profit opportunities.
It’s also good for most taxpayers, who usually gain cheaper and better service. Plus it moves the risk to the private sector if a project turns out to be a money loser.
Privatization isn’t a new idea. States have been using private firms for everything from charter schools to roads to public parks for more than two decades.
But the trend is picking up steam, with more and more functions being handed off, along with greater control. Private companies aren’t just contractors ... they run the show.

Transportation is the biggest example. Chicago got $1.8 billion for leasing its eight-mile Skyway toll road, while a lease on the longer Indiana Toll Road went for $3.8 billion. Va. collected $522 million for a 99-year lease letting Transurban, an Australian company, run a nine-mile road linking two interstates.
But it’s not just roads anymore. N.C. will allow private firms to manage state liquor stores. Boston, NYC, and Kansas City, Mo., are all letting the private sector oversee and maintain some city parks. In Ill., Mass., and Texas, businesses may soon be running state lotteries. Other jurisdictions are privatizing prisons, public vehicle maintenance, street sweeping, debt collection, printing, and water treatment plants.

The push is driven by a need for the quick infusion of money that a lease provides, a desire to cut ongoing costs through efficiency and a concern about future liabilities. Privatization allows governments to get by with fewer workers, indirectly capping skyrocketing benefits.
The moves are usually bipartisan, but not everyone is thrilled. State and municipal unions will likely succeed in blocking big projects in Pa. and Calif., and some consumer groups worry about quality control. But those are exceptions to the rule. Most plans face little opposition.

Businesses that want a piece of the action should be proactive. Get close to local governments so you’re ready when projects are put out for bids. But you don’t have to wait. If you see a need, make your pitch.

Federal Reserve
Will Federal Reserve efforts to ease the credit crunch work?
Not alone. More rate cuts and cash infusions will be needed. And we expect both, including at least one more rate cut by summer.
The Fed’s main goal is to reverse the negative psychology that is weighing on markets and making banks unwilling to lend.
Easier said than done. The big problem is fear of the unknown. No one has a grip yet on how much bad debt is still out there. Lenders want to wait and see, plus they need to build more reserves to handle problems. In short, restoring confidence will take time.

The Fed is fighting a war on two fronts, with limited results.
It’s having some effect on economic growth. Signs are good, if not great. Witness stronger than expected retail sales in Nov. But inflation’s Nov. surge will fuel debate over how quickly the Fed should cut rates. It may decide to wait when it meets on Jan. 30.
Meanwhile, the credit market situation remains troublesome. The Fed has lowered rates one percentage point since Sept., but LIBOR, the global bank-to-bank lending rate, has stayed high. Recent moves by the Fed to increase liquidity have had only a fleeting effect.
A lower LIBOR would alleviate the mortgage crisis in the U.S. About two-thirds of adjustable loans are tied to LIBOR, so any decline would help a million or so homeowners when their rates reset.

Mortgage Fallout
Bush’s mortgage aid plan has already achieved one of its goals:
It will keep Congress from doing anything more drastic this year. Democrats won’t push now for a bill giving bankruptcy judges flexibility to alter the terms of more mortgages. That and other efforts to help will remain on hold while lawmakers keep a wary eye on the mortgage mess.

Some unexpected collateral damage from the mortgage crisis:
Rising loan defaults will hit many retailers and manufacturers that have pushed hard to get into the debt financing game. Their aim was to diversify, find new revenue sources, and boost their sales. But when customers can’t pay, these companies are left with bad debts.
Among the vulnerable: Caterpillar, Deere & Co., General Electric, Pitney Bowes, Boeing, Harley-Davidson, Sony, General Motors, and Ford.

Municipal bonds may also feel the heat from subprime problems. In recent years, bond insurers branched out to guarantee $2.5 trillion in debt, a third in weakened mortgage-backed securities. Now insurers are under pressure from credit rating agencies to put aside reserves.
That will take a toll on the municipal bond market. If insurers need cash, they’ll raise the fees they charge for guaranteeing munis. That forces governments to pay more or go without insurance, a step that lowers cities’ credit ratings and makes them pay out higher yields.