California: The IOU Man Cometh

We're back in California for a couple of days and, having caught a few minutes of the local news from Sacramento a short time ago, there appears to be little progress being made in the effort to avoid state issuance of IOUs in the days ahead.

The local paper carries news that the last day of the fiscal year should be quite an interesting one in the state capital. With each passing hour the odds are increasing that the IOU man cometh.

Both houses likely will be in session all day and into the evening, but look for the real action at the negotiating table in the Governor's Office.

A key issue is $3.3 billion in budget savings that have to be approved by midnight -- in the current fiscal year -- or will be lost forever. Democrats are pushing the cuts to schools and redevelopment agencies to be approved by midnight, but the GOP and the governor want a full package before signing off.

The 1992 version of this melodrama ended badly, with drunken shouting, a fistfight, and a mysteriously stopped clock in the Assembly. Ultimately, the production ran all summer, with IOUs, court fights and rock-bottom performance ratings for politicians of all stripes.

Maybe someone will do the state a favor and roll a hand-grenade into the governor's office and a new group of "leaders" can begin the budget process anew.

Too harsh? Probably.

But, it seems clear that nearly all lawmakers in California are hopelessly out of touch with reality these days, many of them likely viewing the recent economic downturn as being just a temporary setback in what is seen as a birthright of ever-rising real estate prices, the absence of which makes the state, basically, ungovernable.

The idea that an Obama bailout might also materialize, despite recent assurances to the contrary, is no doubt making the sense of urgency a bit less than it might otherwise be.

The San Francisco Chronicle files this report of no progress being made in the stalemate.

Despite a deadline looming tonight, Gov. Arnold Schwarzenegger and the Legislature were at a loss Monday over how to close the state's massive deficit, and there were no signs a compromise would be reached soon.

If no plan is adopted by 12:01 a.m. Wednesday, the state plans to issue IOUs to contractors, vendors, local governments and taxpayers expecting refunds beginning Thursday. The governor plans to force 220,000 state workers to take a third unpaid day off beginning in July; and the state will forfeit more than $3 billion in budget savings through cuts to education that had to be made in the fiscal year ending today.

Before the Legislature adjourned late Monday, Democratic leaders had scrambled to pass a plan to solve the impending insolvency of the Golden State, but the governor fired back, insisting he would not support their budget bills because they included taxes and not enough spending reductions to close the $24.3 billion deficit through June 2010.

"I will veto any majority-vote tax increase bill that punishes taxpayers for Sacramento's failure to live within its means," Schwarzenegger said Monday.

Since the state has had to issue IOUs before (during the 1990s housing bust, by no small coincidence), it seems unlikely that the embarrassment of having to do so again will be any deterrent this time around.

Comments

[Mad Hedge F...:]

Time to pay the piper. As the California budget battle reaches white hot temperatures, Fitches has cut the rating on the state’s debt to A-, and placed it on “credit watch”, a warning of further downgrades. The move is a delayed recognition of reality, as is the rating agency industry’s practice. The legislature tried, but failed to pass $12 billion in budget cuts, which governor Arnold Schwarzenegger said he would veto anyway, because they didn’t meet the full $24 billion tab (see my previous dispairing piece at href="www.madhedgefundtrader...">madhedgefundtrader.com...). In the package were increases in motor vehicle registration fees, $1.50 a pack in additional tobacco taxes, cancellation of health insurance for one million children, a production tax of 9.9% for in-state pumped crude oil, the firing of thousands of teachers, firefighters, policemen, and probation officers, and more smoke and mirrors accounting shenanigans that kick the can into the future. Some of the changes were only possible through a redefinition of the English language that turned “taxes” into “fees.”As California goes, so goes the nation, as many states will follow the Golden State into financial Armageddon. In a new era of soaring unemployment, restrained consumption, high savings, and crashing stock and property prices, states dependant on taxes on incomes, sales, capital gains, and property appraisals don’t do well. Make sure those muni bonds are insured. Why do I get the sickening feeling that I am watching a rerun of Thelma and Louis?

Jun 30 03:20 PM

[DONE_SONZ:]

Like mother(country),like son (state).Cali isn't the only one either.We have alot of work to do.

Jun 30 03:47 PM

[The Geoffster:]

Will there be a mass exodus to Oklahoma?

Jun 30 04:29 PM

[conceptwizard:]

If a private bank can create credit on its books, so can the mighty state of California. It merely needs to form its own bank. Under the “fractional reserve” lending system, banks are allowed to extend credit – or create money as loans – in a sum equal to many times their deposit base. Congressman Jerry Voorhis, writing in 1973, explained it like this:

“[F]or every $1 or $1.50 which people – or the government – deposit in a bank, the banking system can create out of thin air and by the stroke of a pen some $10 of checkbook money or demand deposits. It can lend all that $10 into circulation at interest just so long as it has the $1 or a little more in reserve to back it up.”

The 10 percent reserve requirement is now largely obsolete, in part because banks have figured out how to get around it. What chiefly limits bank lending today is the 8 percent capital requirement imposed by the Bank for International Settlements, the head of the private global central banking system in Basel, Switzerland. With an 8 percent capital requirement, a state with its own bank could fan its revenues into 12.5 times their face value in loans (100 ÷ 8 = 12.5). And since the state would actually own the bank, it would not have to worry about shareholders or profits. It could lend to creditworthy borrowers at very low interest, perhaps limited only to a service charge covering its costs; and on loans the bank made to the state, the state would ultimately get the interest, making the loans essentially interest-free.

Precedent for this approach is to be found in North Dakota, one of only three states currently able to meet its budget. North Dakota is not only solvent but now boasts the largest surplus it has ever had. The Bank of North Dakota, the only state-owned bank in the nation.

Jun 30 05:22 PM

[User 353732:]

California's bond default is perhaps as anticipated as GM's bankruptcy. No thinking investor was surprised that GM failed and no thinking investor will be startled when California stops paying interest and forces vendors to accept fantasy or fiat money known as IOUs.
When incumbents cannot solve a strategic economic problem despite repeated and insincere attempts, markets finally intervene and force a resolution.
Unlike GM, of course, California, for a few weeks, can issue its own fiat currency known as the state IOU. It is backed by the same vapor as the fiat US dollar: as goes the US government, so goes the California Govt.
GM went under and became an object of contempt. The world did not stop and now no longer cares. Too big to fail, failed.

California too will become an object of international derision. Too big to fail, will also fail. The world will not stop and after a few days of howling headlines and MSM fabricated hysteria, will soon cease to pay much attention.
California will still have tax revenues that exceed those of any other state. It will, somehow, with wailing and gnashing of teeth ,switch to functioning on a cash flow only basis.
GM was unable to blackmail the world into endless forebearance and subsidies. Neither will California. The crisis will wonderfully focus minds and separate truth from lies.
The dream is almost over; the night is far spent. Time to arise and face the new day.

Jun 30 05:32 PM

[Graham and ...:]

And those IOUs will trade at large discounts to face value, meaning huge, speculative gains for some, and corresponding losses for others. Just like the early days of America, during the Articles of Confederation.

Jun 30 05:52 PM

[dhansen548:]

Here at last is a place where Wall Street bankers and bond rating agencies can play a positive role and earn the admiration of the entire country, perhaps of the world: form a bond vigilante posse and let California know, in no uncertain terms, that no financial rescues will be forthcoming from any quarter.

Jun 30 06:02 PM

[Socialism c...:]

Since legislators are unable to curtail spending, issuance of IOUs will achieve the same effect -- though probably in different areas. Vendors and suppliers will at some point decide to stop working/delivering on an IOU basis, and those goods/services will be cancelled. Given the Peter principle in effect in government, the budget items that should be cut will not end up being the ones where IOUs cause cancellation. Instead, the most valuable services -- the ones that are truly government's role, instead of entitlements -- are the ones where the vendors/suppliers/workers will cancel or go on strike.

Good luck, CA -- you've sown your own socialist seeds. Hope the Feds learn from you. So far...not so much.

Jun 30 06:36 PM

[W.E. Heasley:]

Can they afford the paper in order to print the IOU's? Maybe e-mail IOU's?

Jun 30 09:42 PM

[Moon Kil Woong:]

It will only get worse. California is already stealing all the tax revenue from local cities and counties to finance their bankrupt system. They have been doing for years yet the ratings agancy kept them at AAA up until just recently. This is just another example why ratings agencies are useless and should just dissapear.

If things get too bad and California rolls back Prop 13, that will be when you'll see what a real housing collapse looks like.

Jul 01 02:50 AM

[TeresaE:]

Michigan already used these tactics 3 years ago.

We are already facing another BIGGER deficit in '10 budget.

NOTHING at the government level has changed one iota since the pain shoved onto the few of us still dumb enough to live here.

Coming soon to a state near you: federal takeover.


On Jun 30 03:20 PM Mad Hedge Fund Trader wrote:

> Time to pay the piper. As the California budget battle reaches white
> hot temperatures, Fitches has cut the rating on the state’s debt
> to A-, and placed it on “credit watch”, a warning of further downgrades.
> The move is a delayed recognition of reality, as is the rating agency
> industry’s practice. The legislature tried, but failed to pass $12
> billion in budget cuts, which governor Arnold Schwarzenegger said
> he would veto anyway, because they didn’t meet the full $24 billion
> tab (see my previous dispairing piece at href="www.madhedgefundtrader...">madhedgefundtrader.com...).
> In the package were increases in motor vehicle registration fees,
> $1.50 a pack in additional tobacco taxes, cancellation of health
> insurance for one million children, a production tax of 9.9% for
> in-state pumped crude oil, the firing of thousands of teachers, firefighters,
> policemen, and probation officers, and more smoke and mirrors accounting
> shenanigans that kick the can into the future. Some of the changes
> were only possible through a redefinition of the English language
> that turned “taxes” into “fees.”As California goes, so goes the nation,
> as many states will follow the Golden State into financial Armageddon.
> In a new era of soaring unemployment, restrained consumption, high
> savings, and crashing stock and property prices, states dependant
> on taxes on incomes, sales, capital gains, and property appraisals
> don’t do well. Make sure those muni bonds are insured. Why do I get
> the sickening feeling that I am watching a rerun of Thelma and Louis?

Jul 01 09:41 AM

[TeresaE:]

In this economy, it isn't that their vendors will "decide to stop working"

The vendors with a fistfull of IOUs will be forced into bankruptcy.

For some damn reason the suppliers' suppliers still want to be paid.


On Jun 30 06:36 PM Socialism cannot compete! wrote:

> Since legislators are unable to curtail spending, issuance of IOUs
> will achieve the same effect -- though probably in different areas.
> Vendors and suppliers will at some point decide to stop working/delivering
> on an IOU basis, and those goods/services will be cancelled. Given
> the Peter principle in effect in government, the budget items that
> should be cut will not end up being the ones where IOUs cause cancellation.
> Instead, the most valuable services -- the ones that are truly government's
> role, instead of entitlements -- are the ones where the vendors/suppliers/workers
> will cancel or go on strike.
>
> Good luck, CA -- you've sown your own socialist seeds. Hope the
> Feds learn from you. So far...not so much.

Jul 01 09:42 AM

[yellowhoard:]

California munis are about to be as volitile as airline stocks. Only, not quite as sound.

Jul 01 01:18 PM

[TinyTim:]

"Maybe someone will do the state a favor and roll a hand-grenade into the governor's office"

"The 1992 version of this melodrama ended badly, with drunken shouting, a fistfight, and a mysteriously stopped clock in the Assembly. Ultimately, the production ran all summer, with IOUs, court fights and rock-bottom performance ratings for politicians of all stripes."

If they got enough of these distressed State Legislatures together, they could provide continuous coverage on a new cable channel. No better drama than the greedy versus the powerful.


"Since the state has had to issue IOUs before (during the 1990s housing bust, by no small coincidence), it seems unlikely that the embarrassment of having to do so again will be any deterrent this time around."

embarrassment, surely you jest. As someone recently said, I wonder if they'll take an IOU for my taxes.

Jul 01 02:22 PM

[snagglesnarf:]

We should ask Jed Clampett for a loan. He's got a cement-pond full of cash and has been known to finance wacky ventures like giving acting lessons to Jethro.

Jul 01 08:16 PM

[TinyTim:]

A better question:
I wonder if they'll take one of their IOU's for my state taxes.

This probably violates the Constitution.

Jul 01 09:10 PM

[Northstar10000:]

Obama WILL bail them out. Then watch the real fun as state after state refuses to make sane budget cuts and lines up at the Federal Bail Out House. After a few states get there bail bond money the howls will be heard across the land. Then the whole thing comes undone as treasury bonds/notes/bills get the heave ho.... Gold/silver anyone !@#$%

Jul 02 11:13 PM

[Northstar10000:]

I heard you can get a double on the IOU gig if you sell them on E-Bay. 2x0= ???

Jul 02 11:15 PM