California must be dreaming

July 1, 2009

Agnes Crane – Agnes T. Crane is a Reuters columnist. The views expressed are her own –

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 (AIG.N), 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. The embarrassing budget impasse has left the Golden State with a $24 billion gaping hole in its state finances and a cash crunch that will force the state controller to send out IOUs for the second time this year later this week.

So far the cash crunch is limited to a $2.8 billion shortfall in July that can be plugged by handing out IOUs to local governments, state vendors and recipients of income tax refunds. But by September that shortfall will swell to $6.5 billion, according to the state controller, and by October, California will need to pay off the IOUs issued this month.

Of course this could be remedied by the governor and state legislators if they could agree on a budget and painful measures to address the cash shortage, but even the June 30 deadline hasn’t been enough to force them to overcome the entrenched dysfunction in the state government.

It should be said that the prospect of defaulting on the state’s roughly $70 billion of bonds outstanding — that includes its general obligation bonds and its Economic Recovery Bonds — is likely some months away, but the rapid deterioration of the state’s finances, the size of the budget gap and the governor’s insistence that short-term borrowing in the credit markets is off the table as a solution, brings the possibility into much sharper focus.

The scope of the mess and state government’s inability to tackle it has caused those with an aversion to drama to sell California municipal debt, pushing up 30-year yields to a lofty 6.2 percent this week, up from the 5.3 percent to 5.4 percent seen in the beginning of May, according to Municipal Market Advisors. The cost of protecting the bonds has also been rising.

Given the unprecedented nature of a California default — you have to go back to The Depression to find a state, Arkansas, failing to meet its debt obligations — there’s an expectation that the federal government would intervene to ensure bond holders are protected, at least partially.

That’s because a state the size of California — it would be the world’s eighth largest economy if it stood alone — would have an extremely difficult time managing its finances without access to the capital markets. It also promises to darken the United States’ black eye from the credit crisis since it would show how weak such big states, which contribute to federal coffers, are.

That could pressure its own cost of borrowing higher as international investors become even less enamored with government debt. California has already asked the U.S. Treasury for a healthy heaping of funds from what has become the catch-all Troubled Asset Relief Program, which was initially created to buy toxic assets from financial institutions, but Timothy Geithner has kept his distance, signaling back in May that any decision to lend a helping hand to the state should come from Congress.

The pressure is likely to mount in the days, weeks and months ahead, however, if there’s no resolution from the state on how to right its finances. Fitch Ratings has already downgraded California’s ratings, and Moody’s Investors Service and Standard & Poor’s have warned that they could do the same if nothing is done.

Negative press surrounding hardships from those receiving IOUs in lieu of cash will also turn up the political heat to do something. The federal government, however, should stay out of the mess and signal more strongly to state politicians and investors alike that they’re on their own.

32 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

From a Texas perspective I just hear a lot of California whiners. Why should the other 49 states of this union send their money their “extra” money to the federal government, only to have it sent to the insane state of California? IN Texas we are REQUIRED by our state constitution to balance our budget!!! We have a surplus this year! It’s not always easy, but it does get accomplished every single year. Lose the superior attitude and start living within your means.

Posted by James | Report as abusive

A state cannot be structured in such a way that it is forced to pay for propositions that the people pass but is unable to raise taxes to pay for them. It is time the people of California demand a reduction in their payments to welfare recipients and get in the black. California has long been known as one of the most generous states to immigrants and the poor. Nice if you can pay for it, but at some point, a hungry stomach is the best incentive for getting a job.

Posted by Em | Report as abusive

DRILL BABY DRILL.
Set oil platforms up and down that coast, and drill your way out of your problems. Use wind power for your local needs, and sell the oil to the states that don’t produce it. Build a new refinery at Pendleton, refine your and others’ oils. Desalinate ocean water, sell the sea salt to other states. Don’t waste the new cash surplus these natural commodities create for CA and now you’ve got ample jobs for your folk with these new initiatives. If the rich have a problem lookin’ out at an oil rig, have your movie folk set up screens in front of it all and show pretty pictures for your rich to enjoy their views, which they never really use anyhow cause they’re outta town not suffering w/ the rest of the CA citizenry.

Next!

Posted by gina | Report as abusive

There are some good words here about why California needs to be allowed to fail or succeed without a bailout.

I do have to disagree with Red-in-a-blue-state and Smith about the saying that “as goes California so goes the nation.” There are many states running surpluses this year and most of the rest are not in such dire straits. The societal values that have put California in a pickle aren’t replicated to the same extreme elsewhere, and I don’t see any current movement to imitate California’s culture in other places. If anything, the state’s reputation is tattered to the point that other Americans want to distance themselves from it.

Posted by civilator | Report as abusive

I went to a private college in California in the late 70s. During the time, I discovered that the state’s community colleges were FREE to residents. In fact, you only needed to live in California for 1 year to qualify for the free college courses. I was only about 19 years old then, and I thought that it was unsustainable, especially with millions migrating and immigrating into the state. Nothing should be free, because it really isn’t free. Too many programs like these can bankrupt a state. Apparently, California had a lot of them.

Posted by ccollins | Report as abusive

I need to set everyone straight. The unions don’t control state government. If they did, we wouldn’t be taking a 15% pay cut, now would we? The union is ineffectual, and exists SOLELY for the purpose of funding Democrat politicians.

The problem with California is that most of the budget is directed by constitutional laws, such as Prop 98, which requires 45% of the state budget goes to the black hole of education in California. Other similar constitutionally-mandated funding means that the legislature is handcuffed in what they can do.

We need to take the handcuffs off and re-write these draconian laws (passed by the people after misleading ads run by the teacher mafia).

Until and unless this happens, the state will continue to be a basketcase.

And firing all state employees won’t solve the problem (BTW, would you please volunteer to house a convicted murderer in your house when there are no prisons? Thank you!)

Posted by Scott S. | Report as abusive

I wonder if those of you that blame “welfare” have ever looked at the actual numbers. You would be amazed at the big wonderful corporations and conglomerates that get welfare, not to mention all the tax write offs. Those are the big WELFARE receivers. Look into it, and yes we have alot of people that never will pay a dime, but again the biggest welfare dollars go to the companies that make billions, and still collect from the govenment. Those little people that get big bucks of about $1000 a month, don’t hurt the state, the tax breaks and write offs, and all the other things the really really rich get is what hurt all the states and especially California. Not too mention the really really rich governor. I don’t know who elected him, because NO ONE will admit to it, but somehow there he is, adding additional problems. I suggest you try to get welfare, if you have worked most of your life, paid into the system, and did your best and was thrown to the wolves by all the greedy, money hungry leeches out there, you will NOT gualify, so you have to either have that foreign name or an additional million in you pocket. But if you do, I doubt you will bother because you will NOT survive. Those little guys don’t hurt us, its less than (I believe) 1%, so before we speak we really should know the facts. It the big guys that want you to fear the little ones. You might find out who really gets all the money.

Posted by Paulene | Report as abusive

HA! A Texan telling others to ‘lose the superior attitude…” That’s more golden then the Golden State itself. The only reason Texas has a surplus this year is because it uses a high property tax and low income tax formula which is the opposite of Prop 13. So when their is a recession that means less income tax dollars generated.

Posted by john | Report as abusive

The solution to California’s and the country’s problem is very easy to conceive but difficult to execute. OUST THE LEGISLATORS. They are thge enemy of the people. As long as the political class stays in existence, we’ll suffer.

Posted by James | Report as abusive

According to an article published by the Reason Foundation titled “What Caused the Budget Mess” The size of California budget(Government) has tripled since 1990 with the budget growing from 51.4 billion in FY 1990-91 to 144.5 billion in FY 2008-09. Yet the citizens of California are not 3 times better off since 1991. But the most astonishing part of the article pointed out that

“If California had simply limited its spending increases to the 4.38 percent average increase in the state’s consumer price index and population growth each year since FY 1990-91, the California would be sitting on a $15 billion surplus right now.”

So I have to respectfully disagree with you Agnes that prop 13 and the 2/3 majority for Tax increases is the cause of the current mess. Prop 13 and the 2/3 majority are the only thing stopping the legislature from taxing the taxpayers of California in oblivion.

The problem with California is as Thomas Paine so eloquently stated: We the voters of California have allow “the ELECTED (officails) to form for themselves an interest separate and aprart from the ELECTORS(voters)

In California we have allowed the California Democratic Party to setup a “Legislative Monarchy” with political succession from within the CDL

Posted by theodore | Report as abusive

To say the least, I was startled by one contributor’s statement that a fire captain can retire at $250+k in California. Curious, I went to the Los Angeles Fire Department’s pension webpage — or tried to. The Google link took me to a page at LAFD saying the file either didn’t exist or had been replaced by another file. So, off to the LAFD homepage. After some time poking around . . . nothing. Curiouser and curiouser still . . . I also am a bit surprised by the spirited defense of Prop 13, though I am not a Californian (and haven’t ever lived there, owned property there, etc.), but, then, I was unaware of the apparently beneficial aspects for the elderly (for example). However, that stuff has to be paid for. How? I haven’t a clue. A federal bail-out could, conceivably, be political suicide for anyone in Washington supporting it, as opponents to such a move would undoubtedly argue it would show favoring one state over the rest (though that ignores California’s status of having the 8th-largest economy in the world if it were an independent nation). Californians will have to expect non-Californians on all sides of the issue to be piping up, loudly, should the feds step in; after all, in that scenario, we taxpayers in the rest of the U.S. will be helping foot the bill, and if we pay for it, that’s a ticket to speak up. I’ve been thinking about the Great Depression and outfits such as the CCC; I guess that wouldn’t wash with a lot of people, especially conservatives, though it would employ a substantial number of people. Maybe a private version of the same thing? What I mean is give a company (one with the wherewithal to pull it off) a significant tax break for taking on public works projects, big ones, projects the company agrees to do for a price providing only the most modest of profits (since it would be profiting elsewhere, in the form of reduced taxes). Sort of like the ideas behind breaks for solar, wind, etc., but on steroids — maybe expand those areas, and toss in roads, nuclear, rail, port modernization/expansion — anything that might benefit the private sector, both workers and companies. Which, by extension, should benefit the various levels of government. Not a tax expert, nor economist, nor public policy whiz .. . none of those things we normally look to for guidance. Just a guy musing over how to help . . .

Posted by Mekhong Kurt | Report as abusive

Californians should vote out Feinstein and Boxer and get real representation in Washington DC. Obama is not the leader of We the People. Bretton Woods or new Constitutional convention?