The Ripple Effect

As Economic Crisis Expands, Community Development Feels the Pinch

William Emmons gives an overview of the credit crisis during a meeting in Conway, Ark. Emmons is an economist at the Federal Reserve Bank of St. Louis.

The economic situation over the last few months has been tumultuous. Fannie Mae and Freddie Mac entered government conservatorship. The potential failures of Bear Stearns and insurance giant AIG required large-scale intervention to minimize market disruption. And the Fed introduced aggressive new liquidity measures to address the seemingly daily changes in economic markets.

This national and global economic crisis hit close to home for professionals working in community economic development. The entire field has been affected by tightening credit and capital markets. Individuals, neighborhoods and cities alike continue to face difficult challenges to finding financing for community economic development initiatives.

In September, community development organizations, financial institutions, private developers and representatives from state and local governments gathered in Conway, Ark., to discuss the implications.

National Impact

The meeting, co-sponsored by the Federal Reserve Bank of St. Louis and the University of Central Arkansas Community Development Institute, assessed the rapidly developing situation by focusing on the direct impact such changes were having on community economic development.

Federal Reserve Bank economist William Emmons kicked off the event with an overview of the credit crisis, its origins and implications for the future. Emmons said the crisis stems from over-leveraging, resulting in increased risk. As he sees it, the challenge facing the Fed and other decision-makers is to not only ensure that the banking system remains viable, but to recognize that every institution may not survive.

Though realistic about the widespread repercussions of the crisis, Emmons was nonetheless optimistic that a rebound could be realized more quickly, given the level of attention from both policymakers and the public. “By bringing this situation to the forefront of the dialogue, we can hopefully come to a quicker solution or stability,” he said. Ultimately, confidence in the system and trust in banks is needed to resolve the crisis, he said.

Conversations throughout the day looked at the breadth of implications that the crisis has for individual homeowners, community development organizations, municipal and state finances, and private developers.

Community development organizations are fighting to make sure the progress made in neighborhood revitalization and homeownership is not lost as a result of dramatic increases in foreclosures.

Don Phoenix of NeighborWorks America said nonprofit organizations that are key to neighborhood stabilization are being forced to look at alternative business models, such as fee-based systems and lease-purchase products, to survive in an era of declining subsidies and deal volume. Nonprofits can be an integral part of the solution, Phoenix said, but they must be responsive to the realities of the changing market.

Cities and counties face challenges in both the short and long term. The most immediate implication is in the bond and tax credit markets where there are few buyers, resulting in a pent-up supply with very little demand. In the long run, municipalities and states both expect revenue and tax receipts to drop. In addition, help from the federal government likely will decrease.

The Response

In the midst of these challenges to traditional development financing mechanisms, states have been responding to the crisis through efforts to combat foreclosures.

Across the country, states are helping consumers avoid foreclosure and stay in their homes by passing foreclosure intervention regulations or laws, preventing rescue scams, funding refinance programs, creating loan-modification programs, initiating statewide counseling campaigns, and supporting foreclosure hotlines. (To read more about state responses to foreclosure, visit the Pew Center on the States at www.pewcenteronthestates.org.)

What’s Happening in Arkansas

Local Arkansans working in the field added a note of optimism to the meeting, saying that, while economic times are challenging, there are bright spots of opportunity.

Scott Beardsley of First Security Bank/Crews & Associates, a national lease corporation with broker-dealer operations, works with municipalities and school districts nationwide. Beardsley’s firm does “plain vanilla” public finance for projects like school buildings and water system bonds, as well as lease-purchase agreements for government entities.

“We’ve seen a dramatic impact on the national leasing stage,” said Beardsley, who suggested that rising interest rates based on fear of the unknown are complicating deals. “But in our broker-dealer operations, ironically, we’ve seen no change.”

Beardsley noted that earlier in September, 17 bond issues were on the ballot in Arkansas. Despite market turmoil, 13 measures passed. That 76-percent passage rate was slightly higher than the 70 percent traditional average.

With voter approval, the bonds are ready for placement, but Beardsley warned that those higher interest rates would be a factor.

“Anytime there’s uncertainty, people are unsure of what’s going to happen, and so they will often pad the interest rates,” he said. “We’re still seeing projects go forward. We do expect all of the bonds that were approved this week to be sold between now and Dec. 1.”

Greg Nabholz is a commercial real estate developer whose company is affiliated with a national brokerage firm and a family-owned construction business. Nationwide, commercial property transactions fell about 74 percent in the first six months of 2008 compared with the same period in 2007, he said. In Arkansas, the year-over-year transaction decline has topped 50 percent. “You’re seeing the number of deals shrinking and thus the commission revenue,” Nabholz said.

He also said three factors have fundamentally altered his business model.

First, lending standards have tightened while greater investor equity is required to jump-start projects.

Second, appraisals are coming in lower because surveyors are being more conservative as they face unparalleled scrutiny.

Third, rising construction costs, from raw materials to labor, and flat leasing rates have compounded the diminishing situation.

“We’ve had to be creative in putting deals together,” Nabholz said.

Amidst the volatility, Gene Eagle, vice president of the Arkansas Development Finance Authority (ADFA), said he sees a window of opportunity for more public-private partnerships.

“My concern is that we get too conservative because of the problems that the rest of the country is experiencing,” Eagle said. “I see it as an opportunity for the state to make an investment in its people, in education and economic development opportunities.”

ADFA is an Arkansas state agency that can issue bonds and direct loans for public housing and limited industrial projects. In recent years, the agency also has been a catalyst for developing pools of risk capital to develop and recruit knowledge-based companies in Arkansas. However, only a narrow range of projects qualify for this type of funding due to state restrictions.

Eagle agreed that market uncertainty was creating higher interest rates for deals—to the point that fewer deals might make sense. He sees it as an opportunity for the state to leverage its low debt and solid credit rating.

“I think we need to utilize our own credit rating as a state, and it’s time to take some risk in order to try to build and grow companies and grow our tax base,” Eagle said. He supports more investment from the state in private, seedling companies with growth potential.

Panelists agreed that Arkansas is not likely to see the dramatic economic downturn in housing that states like Florida or Nevada are experiencing, in large part because Arkansas’ housing market didn’t accelerate as rapidly as housing markets in those states.

Nor is Arkansas likely to see a financial meltdown like Wall Street did. By and large, community banks in the state remained conservative in their lending habits. There was, however, an overextension of housing credit in northwest Arkansas that led to one bank’s collapse and some stern warnings from federal regulators for other banks.

Panelist Paul Young, finance director for the Arkansas Municipal League, a nonprofit organization representing more than 500 cities across the state, said banks in Arkansas have not only remained relatively strong, but have supported the credit underwriting that finances infrastructure projects.

“Arkansas has always been supported by a strong appetite among banks in Arkansas for Arkansas paper,” Young said. “While a lot of these transactions these days are done in some sort of rated format, I see a lot of bonds that are being done on a nonrated basis, as they always have been.” This is because community banks are comfortable with the credit worthiness of the issuers, he said.

Beardsley sees a bit of vindication for firms like his. “We’ve gone in and evaluated each deal based upon the merits of whether or not they’re going to pay. We haven’t used a lot of synthetic derivatives or investment swaps or other items,” he said.

“I’ve had some frustration in the past when clients have chosen to use a Wall Street firm to do a transaction where they’ve promised them a lot of bells and whistles, and now we’re seeing some of that coming back to bite them,” he added.

He concluded that there is some uncertainty in the market, “but we’re ready to take advantage of the core values that we’ve always thrived on.”

Roby Brock is a freelance business reporter based in Little Rock, Ark. He is the host of a weekly statewide business news program, Talk Business, and is editor of www.talkbusiness.net.