The Week in Public Finance: Is the Next Recession Near? 2 Ways to Know

Economists say the unprecedented period of economic growth may be coming to an end.
by | December 7, 2018
(AP/Richard Drew)

The stock market has suffered dramatic losses for two days straight this week thanks to worries about the trade war between China and the U.S. It has caused more economists to warn that a recession may be on the horizon.

Even before the market volatility, economists at S&P Global Ratings issued a report this week raising their recession risk probability. So what does all of this mean for governments, which are coming off one of their highest revenue years in recent memory?

“Even if the worst were to happen, it’s unlikely we will have a full-blown recession for at least another year and a half,” says Moody’s Analytics economist Dan White. But given that states budget one and two years out, “now’s the time to make sure you’re in a good position when that time hits.”

Many states have taken to heart the hard lessons learned during the Great Recession a decade ago. Research from the Pew Charitable Trusts shows that many states' rainy day funds have surpassed their 2008 peak.

Nevertheless, there are a couple things to watch to know whether a downturn is coming.

One is Medicaid spending, which tends to spike when the economy goes sour. That indicator will be a little harder to gauge in states that have expanded Medicaid, but it’s still a “canary in the coal mine” for states that haven’t, says White. The other telltale sign is a dramatic increase in unemployment claims.

Both of these areas so far appear normal.

State revenues, however, don’t automatically start plummeting when the economy slows. There’s usually at least a one-year buffer. That’s because the first revenue that’s affected by a downturn is the sales tax. It doesn't dramatically drop because people still need to buy things, such as food and supplies. Income tax revenue, particularly in states that have a progressive tax system, is far more likely to see stark declines in the event that unemployment starts rising. But that usually has a one-year lag, says White.

Property tax revenue, which many counties and school systems rely on, isn’t always affected by a downturn, either. That’s because many assessments are done every other year, so a short slowdown in the real estate market wouldn’t always register.

In the near-term, most signs point to stability: Unemployment remains low, wages are still growing, and housing prices, which may be cooling in some places, are mostly steady. In their report this week, S&P predicted that a slowdown is more likely to happen than an economic contraction.

“The imposition of tariffs and other protectionist trade policies, ongoing geopolitical concerns and increased risk aversion among investors could hinder growth momentum,” the report says. “If history is a guide, the end to this cycle will likely result from some combination of the bursting of an asset price bubble, an oil price spike or a misstep by the Fed.”

 

In other public finance news this week:

Junk Bonds For Sale

Sometimes bond ratings are about perspective. For at least 20 years, Detroit could sell only bonds that were either backed by the state of Michigan or were protected with pricey bond insurance. But this week, the city sold $135 million in bonds for a wide array of projects on its own credit, despite still being rated at junk status.

The sale is the first time Detroit has entered the market since exiting municipal bankruptcy more than four years ago. That hasn't seemed to phase anyone. In fact, thanks to the low supply in the market at the moment, the city got a lower interest rate -- 4.8 percent -- than it expected. That allowed it to increase its bond sale by $25 million. For all these reasons, observers are calling the event a big financial success for the Motor City.

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