July 25 (Bloomberg) -- East Hampton, New York, where billionaire Ron Baron paid $103 million for an oceanfront estate last year, may have to borrow to close a deficit, as even the richest towns get pinched by rising costs and lower revenue.

The Long Island sanctuary for the rich, where lobster salad sells for $85 a pound, has been hit by a double whammy: a tripling in workers' health costs since 2003, which officials failed to anticipate, and a 43 percent drop in revenue from mortgage taxes related to real estate sales in the first half of the year from 2007. Town officials for the first time plan to reduce the deficit by borrowing, after winning state approval for a $15 million bond sale.

``Nobody likes it and nobody understands how it happened,'' Lance Rost, a 63-year-old retired U.S. Army instructor and East Hampton native, said as he stood in the parking lot of the Amagansett American Legion Hall, eyeing a bucket of freshly dug clams on ice in the back of his Jeep.

East Hampton, whose residents also include billionaire investor Carl Icahn, shows that no municipality is immune from the slowest economy since 2001. The town's bond rating suffered a four-level cut in May. Downgrades of municipal debt nationwide rose 41 percent last quarter from the previous three months, involving securities totaling $10.7 billion, according to Moody's Investors Service.

Not Immune

States may need to increase debt sales to meet funding needs next year, Standard & Poor's said in a report July 14. Deficits are forecast in at least 23 states for the 2009 budget year.

``It's the first time since 1991 we've seen a downturn in both retail sales and property values, so cities face very difficult situations,'' said Michael Pagano, dean of the College of Urban Planning and Public Affairs at the University of Illinois, Chicago.

The U.S. economy is likely to expand 1.5 percent for 2008, down from 2.2 percent last year and the slowest rate since 2001, according to the median estimate of 81 analysts surveyed by Bloomberg News. Consumer spending will post the smallest gain since 1991, a separate poll shows.

Until now, many of the wealthiest communities have been largely immune from the slowdown. Baron, founder of Baron Capital Management, bought 40 acres in East Hampton, a town of 21,000 that encompasses 70 square miles on the south fork of Long Island's east end, for $103 million in 2007. Luxury retail stores from Tiffany & Co. to Coach line the village's Main Street.

`Into a Skid'

Donald Cirillo, an East Hampton resident and municipal finance consultant, likened the fiscal woes to Texas towns faced with higher costs for border patrols, or municipalities such as Vallejo, California, and Yonkers, New York, where officials failed to plan for rising personnel expenses.

``In most cases you have steadily increased costs and those in government aren't paying attention,'' said Cirillo, a former chairman of the National Federation of Municipal Analysts. ``By the time the economy has slowed to the point where revenue goes down, somebody tries to put the brake on spending and the car goes into a skid.''

East Hampton is self-insured to cover health care for its 448 employees and retirees. Costs associated with the plan increased to $9.2 million this year from $2.9 million in 2003, according to the official statement for bond anticipation notes sold in June, one-year securities that helped finance capital projects and improvements.

Rating Cut

Moody's in May cut East Hampton's bond rating to A2 from Aa1, noting the real estate slump. In the second quarter, sales fell 40 percent from a year earlier to 120 homes, according to a July 16 report by Suffolk Research Service Inc., a Hampton Bays, New York-based company that tracks local real estate data.

Revenue from mortgage taxes fell to $2.3 million in the first six months of 2008 from $4 million in the same period a year earlier, according to Suffolk County Deputy Clerk Chris Como.

The downgrade may raise the town's borrowing costs by about 30 basis points, or 0.30 percentage point, on 10-year bonds, or $45,000 a year on $15 million, according to data compiled by Bloomberg.

Borrowing Plans

The town intends in the next several weeks to borrow $4 million dollars or more with a revenue anticipation note, as it awaits receipt of mortgage taxes already collected by Suffolk County, said board member Pat Mansir.

``It still hasn't been determined exactly how much we might need,'' Mansir said.

As of July 22, the town's general fund contained only $900, she said. The town received enough revenue in fees during the next four days to meet its more than $1 million bi-weekly payroll, she said.

East Hampton also plans to sell a $10 million, one-year bond anticipation note in August, and then convert the note into a $10 million, 10-year bond issue that may cover some capital spending requirements along with deficit reduction, said board member Peter Hammerle in an interview.

The board will probably use the remaining $5 million of its borrowing authority by issuing a second 10-year bond issue next year to cover a deficit officials expect in 2009, he said.

``We still don't know how much our medical bills will total,'' Hammerle said.

`Bite the Bullet'

A $10 million issue over 10 years would require a 4 percent increase of East Hampton's property-tax rate, said Town Supervisor William McGintee, a Democrat.

``Once you go down that road you're raising taxes just to pay interest,'' he said. ``I would rather see us bite the bullet now.''

New York authorized 36 bond sales by local governments to finance operating deficits between 1994 and 2007 totaling $296 million, according to a 2007 comptroller's report that described the practice as ``a clear sign of fiscal stress.''

Aside from borrowing, options include cutting services, such as quarterly curbside leaf collections, reducing workers' benefits, raising taxes, or increasing permit fees on everything from party tents to non-resident beach access.

Ending leaf collections ``would be ridiculous,'' said Trace Duryea, 65, a Republican whose late husband, Perry, served in the state Assembly for 18 years.

``To have to collect them and use those awful bags, I don't think the town would stand for it,'' she said.

Town Meeting

Duryea organized a July 22 meeting that attracted 150 to the Amagansett American Legion Hall to discuss the town's plight. East Hampton's fiscal woes have been magnified, she said, by actions like the town board's $6.5 million decision to relocate and remodel eight 17th- and 18th-century barns to Town Hall for housing government offices and meeting rooms.

``It is a little strange, one of the wealthiest towns in the state, at least in terms of real estate values, having financial problems,'' said Republican state Assemblyman Fred Thiele, who represents the town and introduced the bond legislation. ``Finances haven't been properly managed.''

With more than $20 billion of taxable real estate -- or $1 million per resident -- and just $86.8 million of debt, Moody's said the town remains creditworthy. Median home prices still dwarf those across the U.S. even after dropping 11 percent in the second quarter to $1 million, according to Suffolk Research. The median cost of a single-family home in May was $206,700, data from the National Association of Realtors show.

Tax Increase

If East Hampton doesn't cut costs, it might have to raise property taxes by more than 30 percent to cover what McGintee estimated is an at least $8.5 million shortfall in its $38.8 million budget.

For Rost, higher property taxes would erode the fixed income he gets from his Army pension. Rost said he already pays $5,500.

``One thing's certain: The politicians made this mess and we will be stuck with the cost of cleaning it up,'' he said.

While several of East Hampton's billionaire residents have given more than $10 million at a time to charities, none is likely to write a check to cover the town's deficit, said Steven Gaines, author of ``Philistines at the Hedgerow: Passion and Property in the Hamptons'' (Little Brown & Co., 1998).

``The weekend people write lots of checks for things like the local hospital,'' Gaines said. ``They don't like government bailouts, and don't want to pay or even think about high taxes.''

To contact the reporter on this story: Henry Goldman in East Hampton, New York, at hgoldman@bloomberg.net.

Last Updated: July 25, 2008 16:36 EDT

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