California's Sate of Fiscal Emergency Coming Soon to a Theatre Near You

Here it begins folks.... as I stated in last week's piece [The Web of Credit Snares Another: Cleveland]

One point I forgot to mention in the 2008 1st half predictions piece is the role of ever decreasing housing values on state (and city) revenue. A large part of revenue inflows is based on an asset (real estate) that is decreasing throughout the country. Budgets (and benefits) are set to recent 'good times'. Like most enterprises, very few government institutions will save for coming rainy day times - they just assume the good times will continue to roll. But when they don't, they are in trouble. Especially if a very large revenue source starts to shrink (property taxes). And this should be happening over the next few years throughout the country.

What's the solution? Print more money. Wait. You can only do that at the federal government level. So I guess the solution is.... well, I don't know what the solution is.

Again, keep in mind how critical California is - its GDP, if it were as a stand alone country, would place it around #7 in the world. So these 'messy subprime mess' that 'only affects' Ohio, Michigan, Florida, and California... (as the politicians put it), is so much bigger. Housing "only" affects 4.5% of GDP blah blah blah...

I don't know when (or hey, even if) the equity markets will finally come to the realization of the scope of the coming damage, as the bond markets obviously have. But this is only one of many shoes. Again, do you expect home values to go up in 2008? How will California's 2009 budget look? In just over a month the projected shortfall in CA has risen from $10 billion to $14 billion. Give it another twelve months... as many people sitting on overinflated 'assets' are finally going to sell at 20-30% lower prices. Remember, new homes are being sold off at 40% off levels seen in 2006 as home builders are desperate to get rid of inventory price at fair value.

Why do you care if you don't live in California? Well it will be hitting a lot of other states for one, and secondly eventually the "real economy" affects the market eventually, no matter how persistent the 'invisible hand' is in seeing that this will not happen. I repeat, by the time these political candidates get to their primaries, the economy is going to be the 1st, 2nd, and 3rd issue. We're just getting started here.

Fiscal Emergency for California

• Facing a projected $14 billion budget deficit, Gov. Arnold Schwarzenegger on Friday said he will declare a fiscal emergency, which will allow the governor and lawmakers to cut spending more quickly and also sets the stage for slashing state services and programs - perhaps by as much as 10 percent.
• California's fiscal crisis, which is beginning to approach levels that contributed to the 2003 recall of Gov. Gray Davis, is due primarily to a collapsed housing market and related woes in the subprime mortgage industry.
• It doesn't help that while revenues are especially volatile - disproportionately reliant on income taxes - the state has a number of fixed costs as well as guaranteed funding adopted by voters, most notably for public education.

It's just too bad they could not print money. That seems to work 'wonders' at the federal level. Maybe the Asians or Arabs will be interested in high interest rate junk bonds floated by California. And Florida. And Michigan. And Ohio. Luckily the rest of the country has no issues...Wait! Paulson wants local municipalities to float tax free bonds to pay for the housing bust. Wow, it sounds like a lot of credit is going to be needed with all these new bonds that are going to be needed to pay for both the housing bust and to generate tax revenues. All in the fact of a credit crunch. The timing could not be more.... perfect.

Comments

[squawk]

California impending fiscal woes will the be next "big story" to hit the media corridors. As home prices fall, so do ad valorem tax revenues. State operates on a shoe string budget, much like many of the subprime borrowers who purchased assets they could ill-afford.

[Kunst]

California is a financial mess. "The Ahnold" was going to change everything. Instead, we got more of the same. Much more.

California has had a multi-billion dollar structural deficit for years that keeps getting rolled over from present to future. Part of the cause is tens of billions of dollars of bonds that state voters have approved, partly to paper over the deficit and partly to buy things (e.g., highway improvements) without having to pay for them. So now CA has a huge structural deficit and a huge debt burden, while property taxes are already tanking, with sales and income taxes to follow. And you thought the federal finances were messed up!

California will serve as a microcosmic lesson of what faces the US when the borrowing party comes to an end. It isn't going to be pretty. In fact, it's going to be downright painful. Prediction: California bonds will be at junk level within the next 2 years.

[GH]

The solution is simple, and has been used before by other states and cities with consistent succes. It's called a "surtax", and it's simply a temporary tax increase.

Oh no, horrors, we can _never_ increase taxes!

Look, the money has to come from somewhere, CA can't print it, and as Kunst points out if they borrow it they drive their own interest rates up. The fiscally responsible thing to do is get it from the people to whom you are providing services; in other words, raise the price for living in CA.

Either that, or start selling assets.