Commentaries

from Rolfe Winkler:

Obama’s blowout budget

Now that the worst of the financial crisis is behind us, one would think the budget deficit might start to come down. Actually, no. Obama's proposed budget sets a new deficit record -- $1.6 trillion this year compared to $1.4 trillion last year.

The President thinks he can help the economy with more deficit spending. But debt is the reason we have a jobs problem in the first place. We've accumulated more debt than our incomes can support (see chart at bottom) so the economy is trying to pay it down, leading to less spending and higher unemployment. Adding to the debt pile only makes the employment picture uglier in the long-run.

In his blog entry introducing the budget, Office of Management and Budget Chief Peter Orszag tries to argue that the administration is working to close the deficit. Meanwhile the spin from the White House is that this budget marks the beginning of a "new era of responsibility." Of course that's not at all what we're getting. Orszag even trots out the line that we can grow our way out of debt:

Economic recovery – on its own – would take our deficits from 10 percent of GDP to 5 percent of GDP.

But GDP -- a measure of spending -- can't grow unless we're spending more. Seems to me the only way for aggregate spending to grow faster than government spending is for the private sector to spend more. But households are tapped out. They're saving more to repair already busted balance sheets.

We've published the following chart here at Reuters, which illustrates a key talking point for deficit doves:

California debt rush

Talk about a comeback. After a bruising budget fight that forced it to issue IOUs, California plans to sell as much as $10.5 billion in short-term debt later this month.

A reach for yield should trump lingering doubts about the state’s prospects among the small and large investors who are expected to snap up the revenue anticipation notes.

But potential buyers should also be sure to have strong stomachs, as the Golden State remains anything but golden.

The timing for such a sale appears to be good. Confidence in California debt has improved greatly since the state passed its budget, and the minuscule return on most short-term debt means the expected 2.5 to 3 percent yields on the new RANs would give individual investors and mutual funds who invest in such debt a nice bump to their holdings.

RANs essentially borrow against future revenues and are very useful for plugging cash shortfalls, as California well knows — the state raised $5 billion last year and $7 billion in 2007 through these notes that mature in less than a year.

This year, the notes will help bring to an end the IOU saga that brought embarrassing national attention to the state’s fiscal mess, by repaying a loan from JPMorgan Chase that allowed the state to stop issuing the IOUs a month earlier than expected.

But estimating what California’s revenue will be is a tricky business. Just ask the state’s Controller, John Chiang, who is charged with reconciling the state’s estimates with reality on a monthly basis.

California’s topsy-turvy trickle-down

The proposed California budget is looking an awful lot like trickle-down economics. But instead of the classic theory of wealth at the top seeping down to the bottom, the budget would have the state push losses down the pecking order to local governments.

While the full legislature isn’t expected to vote on the proposal until Thursday, the broad outlines of the budget should make the state’s cities and counties shudder, since the proposal would deprive them of already dwindling revenues at a time when borrowing your way out of a jam isn’t much of a fallback plan.

In addition to the proposed $15 billion in spending cuts, the state wants to use roughly $4.35 billion of local funding to plug the yawning $26.3 billion budget gap, according to details that are emerging.

The passage of the budget would be a relief, bringing an end to embarrassing IOUs, and steadying faith in the state’s credit ratings, which had fallen to just a few steps away from junk.

This is crucial for the state, which will need to get back to fund-raising sooner rather than later to make up for time lost during the budget stalemate.

For local governments, however, a bad situation would only get worse.

The budget agreement reached earlier this week proposes to “borrow” $2 billion from property tax revenue that would normally flow to cities, counties and redevelopment agencies. This is coming at a time when these revenues have already taken a big hit from the deeply depressed housing market, double-digit unemployment and a slump in consumer spending.

California IOUs don’t look so hot anymore

Reuters is reporting that California lawmakers are close to inking a deal to close the $26.3 billion budget gap. You know what that means: no more IOUs. So don’t expect to see the IOUs popping up on a trading screen near you.

While a deal will bring the IOU drama to an end, it should create a new one in financial markets: a jump in California muni bonds since an agreement takes the prospect of default – no matter how unlikely it was in the first place – off the table.

From Reuters:

SACRAMENTO, California (Reuters) – California’s top lawmakers told reporters on Monday they were confident an agreement with Governor Arnold Schwarzenegger on a state budget that closes a $26.3 billion deficit would be reached later in the day and voted on by both houses of the legislature on Thursday.

The government of the most populous U.S. state, also the world’s eighth-largest economy, began its fiscal year on July 1 facing the massive shortfall due to a plunge in revenues propelled by the recession and rising unemployment.

A Timmid measure reinforces UK pensions apartheid

At the lower end of the income scale, Britain’s pensions apartheid is well established. Public sector workers are guaranteed an index-linked pension based on their final salary, while private sector workers must just hope their contributions are enough to buy a decent income. Now it is to be applied at the top end as well.

Stephen Timms is the poor sap with the task of cleaning up the trail of ordure left by his boss, Alastair Darling, at the UK Treasury. Two months after the shambles that was the UK Budget, he’s still hard at it, trying to nail down the tax rules for a year that’s a quarter gone.

In April, the Chancellor introduced the concept of “anti-forestalling”, a term coined to prevent people using the existing rules on pension contributions (introduced by Labour) before new ones designed to achieve the opposite effect can be imposed. Darling had no time to think about the details, so he left it to Timms to sort them out.

Timms consulted, and has now administered a brisk kick in the teeth to the highest earners. Those earning over 150,000 pounds will be allowed full tax relief on up to 30,000 pounds of contributions, rather than the 20,000 pound ceiling proposed in the Budget. Even this derisory concession is only available to those who have contributed at least that much annually over the last three years.

Well, serves the fat cats right, you may say. They’ve had it too good recently. Perhaps, but the Treasury’s attack is highly selective.  Anyone who used to make “regular” contributions can carry on as before, allowing those in schemes to escape penalties. “Regular” is defined as at least quarterly, neatly trapping those who may have little idea of how much they will earn until towards the end of the tax year.

Just as neatly, it allows those at the top of schemes to escape scot-free, including the Permanent Secretary at the Treasury, whose department has designed these vindictive rules. Now there’s a stroke of luck.

California dreams shouldn’t include the federal government

Don’t underestimate the power of California, and its ability to suck in a reluctant federal government to bail it out of a fiscal mess of its own making.

But the Obama administration and Congress should resist.

Not only is the federal government shouldering the already heavy burden of sorting out the auto and banking industries, the housing giants Fannie Mae and Freddie Mac and the hard-to-get-rid-of American International Group, but such action would undermine the state’s need to revamp what has become an ungovernable system built on gerrymandering, ill-conceived tax schemes like Proposition 13 and unrealistic restraints like needing a two-thirds majority to pass a budget.

Intervention in California would open another too-big-to-fail Pandora’s box, but one that is much more difficult to navigate politically since the federal government would be dictating which state, and by extension which voters, are worth saving. California, though the most extreme case, isn’t the only state suffering.

In fiscal year 2009, 38 states are experiencing revenue shortfalls, according to a joint survey by the National Governors Association and the National Association of State Budget Officers. Over three quarters of the states have already slashed their budgets by $31.6 billion, but that won’t solve the more than $180 billion gap still projected between 2009 and 2011.

It would also further encourage complacency in the $2.7 trillion municipal bond market, where the assumption persists that no matter how disastrous a state’s finances, investors need not worry about default.

That California has itself to blame as much as the slump in revenues should also make it a hard sell for a bailout.

California faces its moment of truth

The California budget impasse comes to a head one way or the other this week, with state lawmakers needing to make nice by June 30 to close a $24 billion budget gap. If they don’t, rating agencies have threatened to downgrade the state’s credit ratings.

California’s Comptroller said he would begin handing out IOUs on July 2 and the Treasurer said the state will draw on reserves to service the debt of all economic recovery bonds on July 1. (These bonds were created in 2004, when voters gave the state government the authority to raise $15 billion through bond issuance to plug another budget deficit.)

While a slump in real estate and tax revenue are very real factors behind California’s disastrous finances, the San Francisco Chronicle also bullet-points more entrenched problems that have made it difficult if not impossible for the state to surmount extreme dysfunction.

– Partisanship: California’s gerrymandered legislative districts tend to protect incumbents and encourage more political extremes – Republicans on the right and Democrats on the left with less incentive to reach out to the political middle, much less compromise at the Capitol.

– Term limits: Proposition 140, passed in 1990, limits legislators terms to six years in the Assembly and eight in the state Senate.

– Ballot-box budgeting: Initiative-loving Californians mandated set-aside funding for all kinds of single-interest issues, from education to stem cell research.

– Prop. 13: The 1978 landmark law slashed commercial and residential property tax rates, shifting state reliance to other more volatile sources.

– The two-thirds majority rule: The Golden State is one of just three states that require a two-thirds majority vote from each legislative house to pass budgets.

Fitch Ratings cut California’s ratings to A-minus last week from A, and warned that further action could be forthcoming if there’s not a budget agreement beyond June 30.

California general obligation bonds have been getting hit as a result of all the uncertainty. In May, the bonds were trading roughly 37 basis points above AAA-rated munis, according to Municipal Market Advisors. Now they stand at 105 basis points. It’s also helping to drag down the overall market, though returns for the year are still in the black at 5.2%.

The big fear of course is default, but there are many gradations about what they could mean for bondholders.  The worst case scenario would be repudiation, or simply walking away from its debt obligations, though this seems extremely unlikely given the size of the California economy (eighth in the world if it stood alone) and its dependence on future credit market financing. Then there’s defaulting on the debt servicing or paying only part of it.