Raising taxes on citizens whose savings have been hit hard in recent weeks may be an impossible sell, economist William Melton and area mayors agreed, but investing in city infrastructure and maintenance is still important.

What's a mayor to do? When risky mortgage schemes come back to haunt every corner of your city by pushing the economy into a dive so steep that it rattles your innards, what's a mayor to do?

Spend money if your city has it.

That was the counter-intuitive advice that former Federal Reserve economist William C. Melton offered Monday to a gathering of the Regional Council of Mayors in downtown Minneapolis. Melton, also former chief economist at Ameriprise, laid out a crisp analysis of the current financial turbulence, then offered a pro-cyclical prescription that local taxpayers may have trouble swallowing.

Time for cities to invest
But it's the best recourse, he insisted: Now is the time for cities to invest. If they have buffer funds, they should get ready to draw from them and spend as a way to protect assets and stimulate the local economy. If they have no reserves, well, the federal government should supply a brief spurt of aid, he said, adding: "There will be enormous budget pressures."

Mayors already know that part. Minnetonka's Jan Callison wanted clarification: "So this is a good time to spend, and that means raising taxes or spending reserves, if you have reserves?"

Upping taxes on citizens whose savings have been decimated in recent weeks may be an impossible sell, Melton and the mayors agreed, but investing is still important. Bloomington's Gene Winstead made the point that his city — and other inner suburbs — enjoyed a big growth spurt in the 1950s and '60s. The problem now is that lots of infrastructure is aging at the same time.

"You're going to see us dipping back into reserve funds," he said. "We think a steady course is needed. It's important not to fall behind on maintenance. We'd rather not defer; we'd like to continue to pay as we go."

Edina's Jim Hovland agreed, even suggesting the option of borrowing through use of a bond issue. For cities with good credit, as Edina has, borrowing can be an incredible bargain just now, he said.

"We're thinking about expanding our public works facility, and borrowing $15 million or $20 million at an incredibly cheap rate while keeping people working on these projects for a number of years would have benefits," he said. "But then you always wonder at a time of recession if you can add any kind of additional burden to your citizens. Maybe the federal government, as part of its rescue, should loan money to cities at very low interest rates to stimulate some of these things."

Democratic presidential candidate Barack Obama, campaigning in Ohio Monday, offered such a plan as part of his new economic program.

Using reserve funds tricky for big cities
St. Paul Mayor Chris Coleman said that dipping into reserves is well and good for prosperous suburbs, but St. Paul doesn't have reserve funds to speak of. Since 2003, big cuts by the state Legislature in local government aid have moved the core cities onto the critical list, he said.

Still, Coleman said, "We have to continue building our city where we can. We think it's important not to stop the progress we've made because the longer-term problem involves the health of the neighborhoods and public safety. It's a self-fulfilling prophecy: If you stop investing, it's going to make it harder and harder to rebuild your city in the future. It's a little bit of a chicken-and-egg thing. This should be the time to invest, but you don't have the resources to do it. The way the federal and state policies are going, the cities could be on their own."

Patrick Born, Minneapolis' finance director, said he doubted that his city would use its modest general fund contingency. "It's generally held for natural disasters, not for man-made disasters like this one," he said. Officials pointed out that Mayor R.T. Rybak had anticipated a recession during budget preparations last spring, and his budget calls for shifting city spending toward public works projects.

Jim Erkel, transportation director at the Minnesota Center for Environmental Advocacy, said it's important for cities to target such projects to future needs. The market is changing, he noted. When building resumes, there will be more demand for smaller homes in compact, walkable areas with access to transit. Whatever infrastructure is added should reward smaller carbon footprints.

"If you look now at where housing is losing the most value, it's out on the urbanizing edge while traditional urban neighborhoods are holding their value better. The old model was 'drive till you qualify for a mortgage,' but they didn't even include the cost of transportation. That's got to change," he said.

Jim Miller, president of the Minnesota League of Cities, said he was surprised that cities would consider even modest increases in spending at a time of economic crisis. "We're hearing the opposite; that cities are planning to forgo projects. Selling bonds, especially large issues, isn't something that a lot of cities are anticipating."

Melton laid blame for the current crisis on two basic factors: pressure on financial institutions to offer "innovative" mortgage securities that required almost no capital, and a failure by government to regulate the industry. The result is a classic liquidity trap, he said, in which lending freezes up because of fear and lack of trust.

Monetary policy (interest rate cuts) won't fix the problem, he said, but fiscal policy might, either through tax cuts or government spending. Nationalizing banks, for a time, and then selling them back to the private sector worked wonders for Norway, Sweden and Finland in the early 1990s, he said. It's not easy, he said, because governments must decide which banks to rescue. The next wave of home foreclosures must also be addressed, Melton said.

All of that will require deficit spending by governments and tax breaks — like an investment tax credit — for taxpayers.