If This U.S.

Village Can’t Fix It, No One Will April 2011

Two other Garden City, NY residents and I recently experienced first hand
that the majority of the people still support generous politicians. The three
of us ran for seats on our eight-person Village Board, on a platform of fiscal
conservatism. I believe repairing the fabric of our country needs to start at
the local level, which is why the substance of our opposition and the election
results were both fascinating and disappointing. As a result, my conviction
in my investment recommendations has been reinforced. Let me explain.

My hometown of Garden City, NY is a village of 7,800 relatively

conservative households. Our village now employs 300 active unionized
employees and pays pension and healthcare benefits for 200 unionized
retirees. Our school employs 600 active union employees and pays the
benefits for 400 retirees. How a community of 7,800 households came to be
the source of income for 1,500 unionized workers is history, but the current
and future reality is that our unionized employee wage and benefit costs are
driving our village and school costs up at a rate of at least 6-8% a year.
Figure 1. Garden City First Cut Maintenance and Then Started
Borrowing, to Delay The Day of Reckoning
$30 7%

6%
Garden City Total Bonded Debt (Village, $ in millions)

$25

Garden City Street Miles Resurfaced as % Total

5%
$20

4%

$15

3%

$10
2%

Garden City Total Bonded Debt

$5
Street Miles Resurfaced as % Total Street Miles 1%

$0 0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011B
Sources: Garden City financial filings, www.gardencityresidents.org calculations. Note: includes general government, water, pool & tennis.

The residents can no longer handle 6-8% annual tax increases, so for the last
five years the village and school (they are managed separately) have endured
maintenance cuts and increased debt (above). Figure 1 shows such data for
the Village of Garden City. Despite the borrowing, the depressed road
maintenance levels (one example) have gone down. One would think
borrowing would be used to sustain maintenance levels, but this chart is
evidence the borrowing is not being used for maintenance. Instead
borrowed money is being used to pay wage and benefit costs. This is a
double negative that at some point will result in much higher taxes and/or
service reductions.

Our campaign platform was fiscal conservatism, and specifically involved

implementing 15 cost efficiency actions largely developed by village-
sponsored citizen’s budget review committees over the last four years. The
goal was to reduce costs so as not to have to borrow money. We estimated
we could take at least $5 million in costs out of the village’s $52 million
budget, while maintaining services.

We took our campaign to secure three of the eight Village Board seats very
seriously. We had a team of experienced advisors, raised and spent over
$20,000, hired a first rate election attorney, developed a financial slide
presentation and video (http://gardencityresidents.org/video/), spent a week
shaking hands at train stations, hosted friend raisers (aka meet and greets),
mailed each resident a postcard and kept our supporters informed through
regular emails.

The positive aspect of the campaign was that we met residents who share our
view and were willing to donate their time and resources to further the
cause. We had a core of roughly 10 residents and a vocal and supportive
network of maybe another 100. Many other residents offered their “quiet
support” but for various reasons did not engage in the campaign. This was
disappointing and has to change for us to be successful in the future.

Unfortunately, we encountered aggression from the established one-party

political engine of our village. The experience was surreal in this regard.
The incumbents touted the village’s Moody’s credit rating as a reason to stay
the course, used public funds to send out an official village notification
addressing our financial points, tried to discredit us by questioning not the
substance but small parts of our financial analysis (without providing their
own), accused us of owing political favors for donations we received from
friends and resident businesses outside the village and speculated on our
intentions (see Figure 2 below).
From viewing the ad below, one would think we (the Garden City Residents
Party) weren’t even residents. The incumbent Community Agreement Party
spent much less time discussing their platform, their attacks on us were not
becoming of neighbors and towards the end many residents voiced to us that
such attacks increased their resolve in support of us. Still, our fact-based
high road campaign lost out to the reasonable doubt approach of the five
Community Agreement candidates below (three of which are lawyers).

Figure 2. Ideology and Scare Tactics Beat Our Facts

It gets uglier. The incumbents and village management apparently told

many unionized Village employees that we were going to cut their jobs if we
won. After sitting through two years of Village Board meetings, it became
crystal clear to me that the Village Board fears the employees more than
their constituents (the resident tax payers). However, I was not prepared for
the post election display of select unionized village sanitation workers
honking their horns and yelling “You Lost.” I was a target of this
unprofessional behavior as well as residents who had lawn signs supporting
our effort. Just like GM, which you know I researched for 15 years, the
unionized employees now own our village by virtue of their labor
agreements and related pension and health care claims on our future tax
revenues. Their behavior post election is just a confirmation of this fact.
You would think we wouldn’t have gotten any votes given the story thus far,
but we did manage to get roughly 900 votes (35% of the total) compared
with the incumbent’s 1,700. It was encouraging that we were able to more
than double our votes from last year’s write-in campaign (this year we were
on the ballot). It was also positive that voter turnout increased to 2,600 from
1,000 last year and 200 the year before. Still, only 16% of the residents
came out to vote this year. So, maybe as the awareness of the issues
increases we could do better in the future. However, the Village’s
increasing debt load (both bonded and employee-related) is making a
financial turnaround look less likely each day.

Along these lines, the current Village Board continues to take actions that
will only make our situation worse. In December 2010 they approved a
three-year agreement with the CSEA union (one half of our workers) that
was virtually unchanged from the prior contract and still only requires 10%
health care cost sharing. This is despite the fact that the Empire Center
recently said New York pension and healthcare costs could go up 300% over
the next five years. Equally important, the NY Conference of Mayors
(NYCOM) recommends a 30% health care cost sharing percentage for
public sector unionized employees.

The Garden City Village Board also recently gave an arbitrator authority to
negotiate a binding five-year police contract when they only had to give the
arbitrator authority to negotiate two years. Police and firemen can retire in
20 years and currently contribute nothing/zero to their healthcare costs. In
contrast, teachers work 35 years before retirement and contribute 15% to
their healthcare and 25% for that of their family. I personally think the
teachers across the nation are getting too much scrutiny relative to
policemen and firemen. Security is important in the short run, but
uneducated children will make security a major long-term challenge.

Garden City NY is a conservative village that is still not ready to address the
issues. More residents are becoming aware of the financial issues and the
potential consequences (i.e. higher taxes, deteriorating infrastructure, lower
home values, potentially bankruptcy), but the window to properly fix the
village’s cost structure is likely closed. The opposition I get from residents
on this point is eerily similar to that I got from institutional investors when
in 2005 I told them GM would go bankrupt within five years. It is true that
Garden City is a small NY village, but its resident’s general affluence and
conservatism give me reason to believe that if we can’t fix this village then
the U.S. Dollar and our country will be in trouble.

Before the village election, a non-resident friend pointed out that while our
approach was very factual most people live their life based on ideology. He
is correct, and this probably explains why it will take a major crisis to
galvanize American voters around a fundamentally sound solution. In the
meantime, I expect voters to continue to vote to use debt for services and
entitlements that are unsustainable. It is the politicians that have given the
people this option and helped them think it is okay to accept it, without
informing them of the future consequences of such a fiscal approach (i.e.
high inflation, falling home values, civil unrest, etc). These politicians will
be no where to be found when the problems get unmanageable. That I
guarantee.

As for the investment conclusion, I continue to believe that the

municipal, state and federal budget deficits will drive further money
printing and inflation. Commodities, including gold and silver, should
hold their value better than paper currencies. Politicians are in a
predicament or a box (Figure 3). Printing or borrowing money may help the
economy or social order in the short run, but such action has implications for
inflation, social order and fiscal deficits in the medium term.

As I have shown in earlier notes, there is a record amount of debt in our

economy and left alone most people would be forced to go through a healthy
yet painful deleveraging process like in the 1930s. Instead of letting this
happen, governments are spending more than they have and effectively
printing money (and borrowing it back) to make up the difference. Their
idea is that through a controlled inflation the government can reduce the
relative size of the debt and encourage additional consumer borrowing.

If it is unclear how this is happening, I encourage you to read my March

newsletter (http://www.scribd.com/doc/50718213/Balance-Capital-
Advisors-March-2011) in which I role play a conversation between Ben
Bernanke and President Barack Obama.

This money printing may quell the citizens in the short run, by stopping the
economy from falling, but will ultimately lead to an inflation that will
undermine social order. For example, Saudi Arabia’s government (amongst
others) recently gave their citizens additional benefits and jobs as the
citizens prepared to protest. This is effectively stoking inflation and will
ultimately make the protests even worse. The same can be said for the U.S.
government extending the term for unemployment insurance or the recent
healthcare legislation (aka Obamacare).

In order to raise interest rates enough to head off this risk, the government
would just make its fiscal deficits worse. This is because more paper money
chasing a fixed amount of real commodities will eventually drive up bond
yields (because of inflation) and interest expense, which for the U.S. is still
near an all time low as a percent of the federal budget.

The Federal Reserve would need to raise interest rates to a level above
inflation for possibly a few years, and this could make the fiscal deficit
worse and require additional borrowing and/or expense reductions. If you
think there is a way out, consider the box in Figure 3 first. In the meantime,
do not consider your savings safe in paper currencies and paper treasury
bonds. Their purchasing power goes down when any nation borrows and/or
prints money. And, as always, if you need my help with your investments
then email me or give me a call.

Ronald A. Tadross, CFA ∙ Balance Capital Advisors ∙ www.balancecap.com

DISCLAIMER: THIS RESEARCH REPORT DOES NOT INTEND TO MAKE AN OFFER OR

SOLICITATION FOR THE SALE OR PURCHASE OF ANY SECURITIES. INVESTMENTS
INVOLVE RISK AND UNLESS OTHERWISE STATED, ARE NOT GUARANTEED. BE SURE
TO FIRST CONSULT WITH A QUALIFIED TAX AND/OR FINANCIAL ADVISER BEFORE
IMPLEMENTING ANY STRATEGY DISCUSSED IN THIS RESEARCH REPORT.