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Is the State of California bankrupt?

It sure seems like California is insolvent. Just today we heard that Arnold Schwarzenegger contacted Hank Paulson to let him know that the State is having liquidity problems (see pdf) and needs help. California ranks as the world’s 9th largest economy with a population of over 30 million people, so this is quite worrying.

The state had an economy that was going gangbusters during the boom. That certainly aided U.S. GDP growth a few years back. Now, house prices are way down in California — San Diego down 31%, San Francisco down 28%, Los Angeles down 30%. And so goes housing, so goes California. The economy is a shambles, unemployment is skyrocketing and tax revenue is plunging. One city in California has already gone bankrupt. Could the whole state be next?

I certainly think so.

California Gov. Arnold Schwarzenegger warned U.S. Treasury Secretary Henry Paulson in a letter emailed Thursday that the state might need an emergency federal loan of up to $7 billion within weeks, the Los Angeles Times reported Friday, citing a copy of the letter that the newspaper obtained.

California, among several states frozen out of the bond market by the credit crunch, is nearly out of cash to fund day-to-day government operations and can’t access routine short-term loans it relies on to remain solvent. If the state’s inability to access cash continues, Schwarzenegger aides say, payments to schools and other government entities in California could be suspended and state employees laid off.
-Real-Time Economics

If a financial services company were in this kind of shape, it would be on its way to liquidation. Many of us have seen this coming for some time. With property tax revenue down and income tax revenue falling as the real economy begins to suffer, this was inevitable. Other states with huge housing busts like Florida, Nevada and Arizona may be the next areas we hear about in the coming weeks.

Update 2009-01-15:  Governor Arnold Schwarzenegger called California’s huge budget deficit a “rock upon our chest”and warned this is the top priority for policy makers.

The deficit and cash shortage developed rapidly after Schwarzenegger signed the current year’s budget in September. Since then, he’s called lawmakers into three special sessions and twice declared fiscal emergencies. On Jan. 7, he vetoed the only plan that has reached his desk from those special sessions.

Schwarzenegger’s fellow Republicans have blocked his proposal to raise taxes, which can’t be done without a two- thirds vote. Democrats, who control both chambers of the Legislature, have balked at deep spending cuts and proposals to ease environmental regulations and labor rules.

Last month, Schwarzenegger proposed a mix of spending cuts, tax increases and borrowing, as well as an economic stimulus package, efforts to curb home foreclosures and streamlined government operations.

State finance officials are preparing to withhold payments to thousands of vendors and say they will likely have to issue IOUs to people who are expecting tax refunds.

Saving Money

To conserve cash, Schwarzenegger has ordered state offices shut for two days a month and all workers to take two days of unpaid leave each month. The impasse forced a state panel on Dec. 18 to halt funding for $3.8 billion of construction on schools, roads and other public works, a decision officials said might cost tens of thousands of jobs.

“So now the bulldozers are silent. The nail guns are still. The cement trucks are parked,” Schwarzenegger said. “This disruption has stopped work on levees, schools, roads, everything. It has thrown thousands and thousands of people out of work at a time when our unemployment rate is rising.”

California, the biggest borrower in the municipal market, shares with Louisiana the lowest credit ratings among the states because of perennial fiscal shortfalls and legislative gridlock. It is rated A+ by Standard & Poor’s and Fitch Ratings, the fifth-highest grade, and an equivalent A1 at Moody’s Investors Service.

Part of the problem is that some want to raise taxes here to fix the problem. Raising taxes in the teeth of a major recession is a recipe for disaster. However, California will go bankrupt if some form of revenue raising or spending cuts are not taken. The Federal Government will have to step in here with some monies or things will unravel very quickly for California and that will have very negative consequences for house prices.

Sources
Hasta la vista, baby – FT Alphaville
Schwarzenegger Warns California May Need Federal Loan – Real Time Economics
Schwarzenegger letter to Paulson (PDF) – LA Times
Schwarzenegger Says Deficit has ‘Incapacitated’ State – Bloomberg.com
Gov. Arnold Schwarzenegger’s State of the State address – LA Times

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

10 Comments

  1. Concerned says:

    This problem is resulting from our jackass politicians who could get their head out of their own pocket book. The writing was on the wall 10+ years ago when the Internet exploded and sales tax revenue was being lost to out of state resellers. This has mostly been fixed since but the damage is already done. This is just a small example of how California politicians can only see 2 feet in front of them. Insurance requirements, DMV registration, Smog requirements…aka lost vehicle sales (sales tax) these are just a few of the many screwups they have made. Again these problems go way back in time.

  2. vivi says:

    Great but I bet their pleased their GREEN

  3. Paul Baisgele says:

    California IS BANKRUPT, and California must either break
    into 4 or five new California’s, or SECEDE from the Union.
    Vermont is headed for SECESSION from the worn-out
    U S A , and California MUST do the same–and SECEDE!!

    • In a message dated 2/3/2010 09:48:18 Mountain Standard Time,
      writes:

      California IS BANKRUPT, and California must either break

      into 4 or five new California’s, or SECEDE from the Union.

      Vermont is headed for SECESSION from the worn-out

      U S A , and California MUST do the same–and SECEDE!!

      There is another solution. See a report I wrote on this last summer:

      CALIFORNIA’S IOUs OFFER A WAY OUT OF ITS FISCAL CRISIS
      By Marshall Auerback
      Republicans and Democrats alike embraced legislation last week that would
      make California IOUs acceptable payment for all taxes, fees and other
      payments owed to the state – an action that effectively would mean that
      California is entering the currency business. Some commentators, notably Lex of the
      FT, have suggested that the proposed California “IOUs” “would create a
      vicious circle for the cash-strapped state, forcing issuance of even more
      IOUs.”
      Quite the contrary: In fact, California’s innovative IOU proposal
      represents a way of alleviating the state’s fiscal crisis, not exacerbating it.
      While it might appear that the new law seems merely to allow California to
      deficit spend just like the Federal Government – in actuality, the effect
      is far more profound than that. Allowing the IOUs to become an acceptable
      payment method for state taxes, instantly imparts value to them – in effect,
      what you have is a state of the union creating a parallel currency right
      under the noses of the Treasury, alleviating its fiscal straitjacket in the
      process.
      So why are so objections being raised? The confusion seems to arise
      because of a mistaken understanding of the nature of modern money. Modern money
      has no intrinsic value in the absence of state sanction. In the words of
      economist Abba Lerner:
      “The modern state can make anything it chooses generally acceptable as
      money…It is true that a simple declaration that such and such is money will
      not do, even if backed by the most convincing constitutional evidence of the
      state’s absolute sovereignty. But if the state is willing to accept the
      proposed money in payment of taxes and other obligations to itself the trick
      is done.”
      The modern state, then, imposes and enforces a tax liability on its
      citizens and chooses that which is necessary to pay taxes. The unit of account
      has no real value if not ultimately sanctioned by use from the State. By
      extension, the state is never revenue constrained because it alone determines
      what is money. The tax is what gives the currency its value insofar as it
      functions to create the notional demand for federal expenditures of fiat
      money, not to raise revenue per se. Value has been given to the money by
      requiring it to be used to fulfill a tax obligation, but the money is already
      in existence, not “created” by the revenue.
      It is in this context that one has to look at the California IOU proposal.
      It is important to note that the IOU would not replace the dollar, but
      operate in parallel to extinguish state liabilities. And if the IOU becomes
      functionally like a currency, then California’s bankruptcy problems are
      over. By imparting a value to these IOUs (i.e. letting them be used to settle
      state tax) this will ensure a demand for the state’s IOUs. Each individual
      vendor, contractor, or even state employee will accept the state’s new
      warrants up to the individual’s expected tax liability. Eventually the
      warrants will also be accepted by retail establishments and others, including
      banks, which also have liabilities to the state of California—meaning that the
      state could (eventually) issue a number of warrants equal to the total of
      all such obligations owed to the state, on an annual basis.
      There are other historic examples of local currencies operating in
      parallel with national ones. As economist L. Randall Wray has noted, in Argentina
      as the financial crisis deepened after 2000, local governments began to
      issue “Patacones” (bonds with interest) as local currencies, paying workers
      and suppliers, and accepting them in tax payment. Utility companies began to
      accept them—knowing they could pay part of their taxes with them–and
      acceptance spread even to international corporations such as McDonald’s.
      (_http://wallstreetpit.com/8333-berkshares-buckaroos-and-bear-dollars-what-makes-a-
      local-currency-tick_
      (http://wallstreetpit.com/8333-berkshares-buckaroos-and-bear-dollars-what-makes-a-local-currency-tick) )
      It is true that this legislation represents a profound break from all
      federal laws. But this is another instance where Obama’s obliviousness to the
      ramifications of the states’ respective fiscal crises has come back to haunt
      him. He and his advisors keep thinking that if they provide “liquidity”
      to banks, the banks will go out and lend. They don’t seem to understand
      that credit is not a “flow” but a two-way contract between lender and
      borrower: Incomes have to improve first before credit conditions can improve.
      Rising incomes create improved credit worthiness and ultimately improving
      asset values, thereby enhancing lending activity.
      Of course, if the Federal government truly finds California’s proposals
      far too radical, then there is a simpler solution at hand: a payroll tax
      holiday and revenue sharing with the states will go a long way toward
      alleviating the states’ respective fiscal crises and almost instantaneously improve
      private sector incomes and aggregate demand.

  4. BOB EDDY says:

    WHY THEY ARE GIVING ANY STATE EMPLOY BEST BENEFITS,BEST SALARY AND VACATION AND RETIREMENT PLAN WHEN PRIVATE COMPANY CAN NOT EVEN EFFORD TO PAY MORE THAN MINIMUM WAGES, THEN CUT THEIR SALARY 10 OR 15% IS JOKE , THEY SHOULD HIRE THE MOST $10 AN HOUR, BENFITS WILL BE NEW OBAMA HEALTH PLAN CAN BE CO-PAID. UNLESS THEY DO THAT COUNTRY,STATE CAN NOT COME OUT OF RECESSION.

    BOB

  5. BOB EDDY says:

    state employ should get maximum $10 an hour, no benefits ,they are very big liability to tax payer, when you go to any state office big line because they are very lazy and unionized.