California Won't Even Accept Its Own IOUs

California governor, Arnold Schwarzenegger wants everyone to treat his state's IOU's like money – from the citizens and businesses receiving these scraps of paper in lieu of cash, to the financial institutions who are supposed to swap them for legal tender. The problem is that the state government, itself will not accept its own IOU's as payment for debts – at least not until their “maturity date” in October.

In the meantime, small-business owners like Nancy Baird received a $27,000 IOU from the state government for supplying garments to a state-run youth camp, but after two banks refused to redeem her IOU, was forced to pay cash out of her own pocket for the sales tax on the transaction. She and numerous other small-business operators have filed a class-action suit against the state alleging the state has violated both the Fifth and Fourteenth Amendments. The plaintiffs seek full payment for what they are owed by the state – with interest.

Even if the state survives this challenge, the obvious question to ask is what will change for the state between now – when it claims it can't cover all its own IOU's – and October? The answer is: things will be a lot worse. Virtually every state in the U.S. is being to forced to make negative revisions to their budgets every couple of months to adjust to the most rapid plunge in state revenues in history.

Thus, by the time October rolls around, the state's financial picture will have deteriorated significantly at the same time it is supposed to produce several billion dollars to redeem all its IOU's. The only “plan” the state has is to try to borrow more money between now and then. In other words, the California government's state finances are now a Ponzi-scheme – where they have to borrow ever-larger amounts of money to pay off those at the front of the queue to collect their debts.

This is nothing new. It was the U.S. federal government which started Ponzi-scheme financing as a permanent means of financing a nation. To make its balance sheet look much, much better, the federal government does not carry its future obligations on its own books – like every business in the United States is required to do by law.

Instead, the U.S. government calls these future obligations “unfunded liabilities” - and simply pretends they do not exist. Then when Americans actually make claims against these unfunded liabilities (now somewhere in excess of $70 trillion), these expenses are a “surprise” to the two-party dictatorship in power. Worse than that, the federal government has plundered trillions of dollars from its own Social Security “trust fund”. Clearly, “federal government trust fund” is an oxymoron.

As a result, the United States is hopelessly insolvent. Merely transferring its own obligations officially onto its books would instantly bankrupt the U.S. - as it is totally incapable of paying the interest on those obligations. The only option other than immediate default would be to instantly descend into hyperinflation, since it would be totally cut off all international credit (no one will lend to someone who can't even pay interest on its debt).

The truth, of course, is that the U.S. is already incapable of paying the interest on its humongous debts – even through borrowing. As I wrote yesterday (see “Federal Reserve SECRETLY buying Treasuries at auctions”), the U.S. government is trying to hide the fact that it is already forced to print money just to pay interest on its debts by “buying” its own Treasuries indirectly, through intermediaries.

What transforms this from a “national crisis” to simply being “totally screwed” is that state and local governments saw how “well” the federal government was doing with its Ponzi-scheme accounting and decided to copy it. They too took their future obligations for pension and health care benefits off their books, et voila, all these governments were instantly much richer.

We all know what politicians do when they feel rich: they spend lots of money to buy votes. In this case, the “easiest” way for U.S. state and local governments to buy votes was to fatten up health and pension benefits for its own workers – since it didn't need to put any of those lavish promises onto its books, thanks to the magic of U.S. Ponzi-scheme accounting. Now, claims are starting to be made on those benefits at exactly the same time that every level of government in the United States is facing their worst financial crisis in history.

In another news item released a couple of days later, South Carolina's municipal leaders descended onto the state government pleading for state funds to bail them all out of their “unfunded liabilities” nightmares. They claim their plight is so desperate that they are nearly at the point of having to choose between paying police officers and firefighters to perform their duties or pay the benefits the promised to retired police and firefighters.

This brings us back to California's own fiscal meltdown. Even with issuing his bogus IOU's and borrowing every penny he could, Schwarzenegger is attempting to squeeze billions of dollars out of local governments to essentially force them to pay for his fiscal irresponsibility. Is there any reason to believe that California's local governments are at least in as desperate a crisis as South Carolina's local governments? How would those South Carolina municipal leaders react if they arrived at the state capital seeking hand-outs, and instead were told that billions would be squeezed out of their revenues to try to close the state's budget-gap?

Given the severe implosion of California's economy, it is only logical to assume their local funding crises are even worse than those in South Carolina. Thus, as we pass the mid-point of summer, and autumn approaches, we find that California has still done nothing to solve its own fiscal crisis. Instead, it has only delayed financial Armageddon for a few months, while simultaneously ensuring that most of California's local governments face financial crises at least as bad as those of the state government.

Comments

[bluesmoke:]

That can't bode well for municipal bonds.

Aug 10 04:33 PM

[Prudent Man...:]

"In God we trust. All other pay cash. The saloons have more sense than Congress. With all the time our politicians spend in saloons you would think some common sense might rub off on them.

Unless you believe in the Tooth Ferry, it's pretty late to be concerned about Muni Bonds.

Aug 10 04:38 PM

[GlobalTrekker:]

This is all tired Uni-bomber-lite stuff (twin-party dictatorship, indeed). When was the last dictatorship you lived in that allowed you to cash out all your securities, climb on a plane, and fly to another country to live? California is in a mess. It has everything to do with a horrible state constitution and a bad economy. But in California it's easier than anywhere else in the country, maybe in the world, for the people to directly change the government's structure by popular referendum. That's how we got that acting fool in as Governor in the first place. The unexciting truth is that CA will muddle through this. and in a few years CA, and the U.S. will be back to its *normal*, more moderate fiscal sloppiness. And we, and the country more broadly, will be fine but poorer. This is the grown-up results of our profligate spend and borrow culture.

Aug 10 05:05 PM

[Kristjan Ve...:]

I'm surprised that the people of California haven't yet started rioting, or at least protesting en masse. Holding (private) tea parties with a few dozen participants is not going to change anything. Sooner or later, the people of California will probably realize this and at least hold a massive protest. People in China, the EU, African countries and elsewhere are holding protests. The French are even kidnapping their bosses to make them work harder to save their jobs. What are the Americans doing? Holding tea parties and accepting IOUs.

Aug 10 05:07 PM

[dybydx:]

wasnt craig's list selling these IOU's or some groups of private equity funds looking to auction purchase these instruments at 85 cents on the dollar?

Aug 10 10:05 PM

[MarkitWacha:]

Here's how I intend to stay solvent for the next few months:

Long: put options on Sept. TLT

I'm waiting for a clear signal before getting back into commodities. DBA looks to be almost stable.

Volume is way down on SPY, and it's about time for it to crater. Stay vigilant.

Aug 11 12:19 AM

[Northstar10000:]

SPY will implode -- buy SDS and watch the fun. You ain't seen nothing yet.

Aug 11 02:29 AM

[stocknerd:]

I'm sure tired of "its the government's fault." It is the people's fault for wanting a government and not paying taxes. People, stop whining about all the taxes you think you pay. If you want to cut government let's start with the police and the fire dept. MOST of any city budget is to pay for the cops. If you don't like taxes move to Sweden or England and you will soon find out how easy we lazy capitalist here have it.

Aug 11 09:06 AM

[Marvin Clark:]

Unfortunately, you are correct. The next bookmark in American history will be the collapse of the twin financial towers: California and New York. For California, the richest state in the union, this is more of a political crisis than a financial. But, it is reaching a point of no return in easily fixing the problem.

Aug 11 09:32 AM

[marco caricom:]

Sorry, but it is the Gov.'s fault...... for extreme mismanaged allocation and wasteful spending of our taxes, for a terrible sense of entitlement, and arrogant misuse of power as well as reckless open-ended borrowing. They do however take care of themselves quite well.

Responsibility also rests on those who repeatedly reelect such unworthy non-representatives in congress and other political branches of government.

By the way, what is the source of your income/capital ? Are you really a "lazy capitalist" ?


On Aug 11 09:06 AM stocknerd wrote

> I'm sure tired of "its the government's fault." It is the people's
> fault for wanting a government and not paying taxes. People, stop
> whining about all the taxes you think you pay. If you want to cut
> government let's start with the police and the fire dept. MOST of
> any city budget is to pay for the cops. If you don't like taxes move
> to Sweden or England and you will soon find out how easy we lazy
> capitalist here have it.

Aug 11 10:47 AM

[Glen L.:]

Of course it's government's fault, no matter how tired some people are of hearing it. Democracy is to blame, too, because it always devolves into gaming the system by special interest groups, each vying for a bigger slice of the pie than they put in via taxes. This is just human nature, and nothing can be done about human nature. The communists and socialists try to deny human nature by forcing one-size-fits-all social programs down our throats, but you can judge for yourself just how successful that's been over the years.

What can be done is to limit the size and power of government, thereby limiting the power of the special interests. The silver lining in the fiscal problems of NY, CA, the USA, and all the rest, is that this is happening now, literally by default. If enough people realize that relying on government to self-correct by the democratic process (and more taxes) is simply impossible, maybe there will be real, radical reform in our country. But I'm not holding my breath.

Aug 11 11:26 AM

[swaps:]

Is it a coincidence the state with the biggest budget crash is the same state with legalized Texas tea consumption? People enjoying Texas tea are mentally distracted from staging quaint taxation tea parties. "What, Me worry?"

Aug 11 11:57 AM

[Jimbo:]

Let me get this straight, are you saying that the state of California is refusing to take its' OWN OIUs and insists on cash for sales tax??? There are even more fools in Sacramento than I thought. WE GET THE GOVERNMENT WE DESERVE !!

Aug 11 01:42 PM

[awake09:]

Texas tea is oil, no? Do you mean Mary Jane? It's still not "legal" here, but available with a prescription. Believe me, these potheads that fill CA cities want it 100% legal. They are using the legalization concept as a means to pay off the state deficit. Doesn't that tell you how much (taxed) pot they intend to smoke?


On Aug 11 11:57 AM swaps wrote:

> Is it a coincidence the state with the biggest budget crash is the
> same state with legalized Texas tea consumption? People enjoying
> Texas tea are mentally distracted from staging quaint taxation tea
> parties. "What, Me worry?"

Aug 11 01:42 PM

[AlienFrog:]

It's both the people's fault for being ignorant and voting for hollow suits and ridiculous promises. It's the politicians's fault for being corrupt, lazy, ignorant, and interested in only one thing, re-election. We do indeed have a twin party dictatorship, but that is not the worst of it.

The worst is that the two parties are barely differentiable on the world political scale. They basically promote the same policies and are beholden to the same lobbyists. Neither side of the aisle has any interest in rocking the boat; they just want to get re-elected to what are some of the cushiest, most secure jobs in the world.

Americans pay lowish taxes and ask for very little in return. The result is a government which spends trillions on war and death but much, much less on education and health care. There is little accountability, especially since 9-11, that magical date that eviscerated the Constitution. Americans were sold the dream; they paid for it using borrowed money.

Scandinavians I know are thrilled with their social and fiscal system. They would love to pay lower taxes but not if it means changing their system or selling out their children's futures.

Aug 11 02:10 PM

[Jason722:]

This is EXACTLY the backwards stupid logic that gets governments what they want. I am so tired of hearing this line from elected officials: what? You won't give me more money? Well, then I have no choice but to fire the police and firefighters.

That is friggin ridiculous! When my family was running out of money we did not cut food out of our spending. We did not stop paying our meager rent. We cut things there were not essential. We shut off cable. We sold a car and made do with public transportation. We kept lights off and air conditioners off as much as possible to keep electric bills down.

There is so much waste and useless spending in government (let's start with salaries AND BENEFITS of our elected officals, their staff, and other public workers) and most of it is in areas that government is not even chartered to be. PLEASE stop lying that if we need to cut spending, it must be in the very very few areas government is supposed to support!!

On Aug 11 09:06 AM stocknerd wrote:

> I'm sure tired of "its the government's fault." It is the people's
> fault for wanting a government and not paying taxes. People, stop
> whining about all the taxes you think you pay. If you want to cut
> government let's start with the police and the fire dept. MOST of
> any city budget is to pay for the cops. If you don't like taxes move
> to Sweden or England and you will soon find out how easy we lazy
> capitalist here have it.

Aug 11 02:44 PM

[Gregman2:]

California is a state of two minds...one of which is working.;-)

Aug 11 07:04 PM