Mayor Nutter's Budget Update | The Current Economic Context

The world economy is in the grips of an economic downturn the likes of which few people alive today have experienced. According to the International Monetary Fund “world growth is projected to fall to ½ percent in 2009, its lowest rate since World War II".ⁱ This deep downturn in global economic activity is the result of severe dislocations in global credit markets, the collapse of critical banking firms, the bursting of housing bubbles in the United States and much of Western Europe, a seeming halt in consumer and corporate spending, and losses in equity markets that as of March 2009 approach 40%. The economic downturn as of this writing is now in its 15th month and shows no signs of abating quickly.

The policy responses from national governments, led by the United States, to implement sizable fiscal stimulus to prop up demand and restart private spending will be an important, perhaps the most important, ingredient in any recovery in global demand and a return to long term economic growth. That return to growth will not be immediate, though.

For US local governments like Philadelphia’s, the loss in revenues caused by economic contraction and the rise in required pension contributions resulting from the severe losses in equity markets has led to budget shortfalls, unique in their massive size and the speed with which they have occurred. Many cities have resorted to deep service cuts to balance their budgets; some, like New York, have supplemented these cuts with new revenue and expected savings from their employee unions. And the early expectation by some observers that the American Recovery Act funding, the US plan for fiscal stimulus, would help fill budget gaps at the local level has not materialized; as President Barack Obama and his administration have made clear, stimulus funding was not created to close the large budget gaps experienced at the local level.

The speed and depth of the recession has prompted local government leaders to act quickly to close projected budget gaps. Philadelphia arguably was among the first cities to address its fiscal challenges: in November 2008 Mayor Nutter implemented actions, some in partnership with City Council, to close a $1 billion projected gap in the FY09- 13 Five Year Plan. At that time the Mayor and his administration warned that the nature of the unfolding recession made it likely that the Administration would have to close another deficit for the Five-Year Plan beginning in FY2010. Unfortunately, those warnings proved to be accurate: in January 2009, Mayor Nutter announced that the City was facing a $1.045 billion gap for the FY10-14 Five-Year Plan; the decline in revenues and increase in pension related costs which created this second large deficit.

The chart illustrates the projected losses to Philadelphia’s revenues, as a result of the economic crisis. As of November 2008, losses for the FY09-13 plan totaled $1.035 billion, and as of January 2009, losses for the FY10-14 plan totaled $1.045 billion. Current plan projections show an additional loss of $333 million.

Recession: Impacts on Philadelphia’s local economy

According to the National Bureau of Economic Research — a nonprofit organization that determines national business cycles — the U.S. economy is in a recession that began in December 2007.

A downward trend in the national economy bodes poorly for Philadelphia because the City’s economy is directly linked to that of the nation.

U.S. Economic Growth: A sharp downward decline

Real Gross Domestic Product (GDP) is one of the key indicators of economic activity: following Real GDP allows people to see whether a country’s overall economic output increased or decreased, regardless of changes in price.

Preliminary estimates from the Bureau of Economic Analysis (BEA) show that U.S. Real GDP took a sharp downward turn in the fourth quarter of 2008, contracting at an annual rate of 6.2% compared with a 2.8% increase in the second quarter of 2008. Blue Chip Economic Indicators, the International Monetary Fund (IMF) and the Congressional Budget Office (CBO) all project a continued contraction in GDP for 2009, with annual estimates of -2.6%, -1.6% and - 2.2%., respectively.

From a historical perspective, the current economy is fairing worse than the recession of 1982 where annual economic growth hit a low of –1.9%. The graph shows the fluctuation in real GDP since 1945, and its decline during the last year.

(Note: 2009 data are projections; Source: Bureau of Economic Analysis, GSP: Fourth Quarter 2008 (preliminary), February 2009; Blue Chip Economic Indicators, March 2009; International Monetary Fund, World Economic Outlook Update, January 2009; Congressional Budget Office, Economic Projections, January 2009.

Unemployment

Unemployment rates continue to rise across the U.S. as a consequence of the deepening recession. According to the Bureau of Labor Statistics, since the start of the recession in December 2007, 4.4 million jobs have been lost nationwide while the average work week fell to a record low of 33.3 hours. In February 2009, national unemployment reached 8.1%, while Philadelphia reached 8.9% in January 2009 (the most recent available data). Some forecasters anticipate that the national economy will lose an additional 2.5 million jobs this year, with unemployment exceeding 10%.

Most major national industries are experiencing decline, with the largest losses incurred in the manufacturing and construction industries. Locally, Philadelphia’s financial, leisure and hospitality industries have been performing worse than the nation in FY09. Meanwhile, Philadelphia has maintained positive but slow growth in the education, health, professional, and construction sectors.

Philadelphia continues to experience higher unemployment rates than the surrounding counties of Bucks, Chester, Delaware and Montgomery, as well as the nation. The graph shows U.S. and Philadelphia unemployment rising since the start of 2008, in sync with the timing of the economic and financial crisis.

Stock Market

Since the fall of 2008, global equity markets have incurred losses in value approaching 40%, causing a dismal ripple-effect worldwide. Banks saw asset values diminish, and many were forced to merge or collapse. The credit and equities markets plummeted to unprecedented levels soon afterwards.

The weakening stock market has been detrimental for Philadelphia, causing losses in the value of the pension system. As of July 2008, the actuarial liability of Philadelphia’s pension fund was $8.4 billion, of which approximately 55% was funded. As a result of this year’s market losses, it is likely that that percent will decline substantially.

Within this difficult context, Philadelphia’s pension fund has fared relatively well thanks to the prudent investment strategy that the City has maintained. The fund has exceeded the benchmark return in each of the last 4 years, FY05-FY08. Performance for the fund FY09 to date (through January 31, 2008), has continued to exceed its benchmark,-22.92% versus -25.17%. The fund has also exceeded its earnings assumption rate of 8.75% in 4 of the last 5 fiscal years. Within a universe of public defined-benefit pension funds valued over $1 billion, Philadelphia’s pension fund ranked in the top third in FY08 in earnings.

Despite that relatively strong performance, the collapse of the markets has led to substantial losses for the fund. Those losses must be compensated for through increased contributions from the City. The weakening markets and the collapse of lending have also made it increasingly difficult for Philadelphia to market new pension obligation bonds, which were a significant element in last year’s Plan. The City has therefore delayed the issuance of proposed pension obligation bonds indefinitely and does not assume any savings from these bonds in this Plan. If market conditions make it desirable and prudent, however, the City will move forward with a bond issue.

i. International Monetary Fund, January 2009 World Economic Outlook