California: Hell as IOUs

I was asked to comment on California's budget predicament. The state has just started issuing IOUs to its suppliers - not exactly a reassuring sign for a borrower that still sports an A/A-/A2 rating for its GO bonds from the major rating agencies.

SAN FRANCISCO (Reuters) - California's lawmakers failed to agree on a balanced budget by the start of its new fiscal year on Wednesday morning, clearing the way to suspend payments owed to the state's vendors and local agencies, who instead will get "IOU" notes promising payment.

Just about every financial spin-master I have read places the blame on government inefficiency, gerrymandering, etc. In other words, they say this is politics as usual - if a bit less so given the current depth of the economic crisis. No one seriously considers the possibility of default, assuming the federal government will be forced to bail out the country's most populous and economically important state. After all, if California was a country it would have the eighth largest GDP in the world.

But. California in NOT a country, it does NOT have its own central bank and it does NOT issue dollars. It issues bonds priced in dollars, which is an entirely different matter. In that, it resembles Argentina back in the 1990s when it hard-pegged its currency to the US dollar, with disastrous results.

What matters, then, is how the real economy is doing in California. Two charts:

• For the three major metro areas in CA, home prices are off 43% from the top reached three years ago. Home prices are crucial because local governments derive a big part of their revenue from real estate taxes.

click to enlarge

CA Home Prices Off 43% From The Top

(Data: S&P)

• Unemployment is soaring in California. It just touched 11.5% in May, the highest rate in at least 33 years. Payroll and income taxes are collapsing.

Unemployment in CA Soars To 33-Year High Chart: FRB St. Louis

Quite obviously, then, the budget crisis in California is fundamental in nature; it's not a party-politics stand-off to score points with the voters. It won't be easily fixed in a (non-smoking, surely) back room where deals are cut and backs are slapped. This is REAL and is happening in real-time.

Default probability? Certainly a whole lot higher than the A/A-/A2 ratings would suggest.

• Addition: It is instructive to consider facts with all political baloney stripped away. California's general fund revenues are around $100 billion and are derived as follows: 50% personal income tax, 35% sales tax, 10% corporate income tax (see table below).

Source: CA Governor's 2009-10 Budget (.pdf)

The current budget deficit is projected at $26.5 billion, i.e. 26.5% of revenue. No further discussion necessary.

Comments

[dixie]

This famous quote hits the nail on the head:

Thomas Jefferson: "When the people fear their government, there is tyranny; when the government fears the people, there is liberty."

It is time for people to speak-up.

2009 Jul 02 11:15 AM

[conceptwizard]

If I wanted to buy something at a store for $10,000 and I said well I have not got the money right now but I am good for it. I will just give you an IOU for the $10,000 payable at some unknown point in the future. I wonder what the odds would be of me walking out with my new purchase.
In my opinion California is already bankrupt, not going...going but gone...gone. The Fed cannot set precedence with California bailouts with 47 other states without balanced budgets. Thirteen States are already out of social programs money and borrowing from the Fed. Where does it end?

California is not capable of making the hard choices it needs to become fiscally responsible. If "Snigger" can't get it done then step down and let someone else "GET ER DONE".
As a taxpayer I am tired of bailing "EVERYONE OUT"!

2009 Jul 02 11:20 AM

[whidbey]

The implications of states going bust are critical to the national recovery, and reflect poorly on the capacity of popular politics to make hard choices. The US is in deep trouble with no cultural resources to backup the necessity of major life style cuts.

From a generation that did not save (the Boomers), used debt like it was free and now refuses to make concessions to reality, it is fairly clear that nothing will happen in CA or nationally. The depression will come on the double dip in the economy as BO spends til it kills. Yes, we are in trouble.

2009 Jul 02 11:55 AM

[Socialism cannot compete!]

Time to end entitlement government:

1) It is socialism. Which results in created dependence on government, and from the other direction, overly large and overbearing government.
2) It is the buying of votes.
3) It is not economically sustainable. Do we STILL not understand this?

The only way out is to cut government to its intended core functions. We are soooo far from what the Founders instituted...it should not be a wonder why we are in this mess. Personal responsibility and "earn what you need" are the ONLY route to sustainable prosperity AND social order.

2009 Jul 02 12:27 PM

[BerkeleyBob]

The article was better than the comments following. Additional factors for consideration: California is a net exporter of tax revenue to DC. California has an incredibly complex scheme for public education finance, including an elected czar of education and mandated expenditure preference. (Education criminal justice and welfare are the predominant expenditure categories.) California's per capita expenditure for pupils ranks near the bottom--47th place or so. If the governor eliminated the entire state employee payroll , the savings would not make a dent in the present deficit. Altogether aside from the chronic difficulty with the budgetary process, there is a pressing need for a long term structural overhaul of the fiscal relationship between the federal, state, and local governments.

2009 Jul 02 01:29 PM

[Steve in Greensboro]

On what Constitutional basis would the U.S. government make grants or loans to one of the state? What Article of the U.S. Constitution permits this? Anybody? (...crickets chirping...)

2009 Jul 02 01:36 PM

[Valley Boy]

The only action which could be construed as a bailout I would be in favor of would be for the state government to transfer certain state parks to the federal government to be turned into federal parks. The state government has demonstrated that it cannot properly take care of the state park system despite the voters approving bond measures for that same purpose several times over several years. There are a handful of famous scenic areas popular with tourists and therefore profitable for business which need to be preserved. These areas are Tahoe, Big Sur and a couple of other coastal strips, the Redwood National Park area, and a desert area east of San Diego.

2009 Jul 02 02:02 PM

[Moon Kil Woong]

If you want to kill your State economy just follow these simple steps. Let's compare them to california: 1) Steal money for infrastructure etc. from the counties. Check 2) Institute a sales tax on everything over 10%. check. 3) Let your banks be the most corrupt around loaning to people with no income. check 4) Base your government's budget on the false home price explosion. check 5) Rank in the bottom 5 most underfunded State education systems. check 6) Let your bonds slip below investment grade. check 7) Elect a Governor who edits muscle magazine in the State capitol, check 8) Fund your working capitol on county and city money that you delay giving it back to them for months on end. check. 9) Breed the worst gangs in the world. check 10) Have over 2% of your population criminals and over 1% in jail at all times. check.

Gee... I guess California passed the test.

2009 Jul 02 11:57 PM