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.

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 –
Gov. Arnold Schwarzenegger’s State of the State address – LA Times


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.