*****California Leads Nation to Bond Default Abyss*****

Bloomberg reports that California leads nation to bond default abyss.

(emphasis mine) [my comment]

California Leads Nation to Bond Default Abyss: Kevin Hassett
Commentary by Kevin Hassett

June 1 (Bloomberg) -- There is an old joke that a borrower dies if everyone stops believing in him. A look at the history of financial crises suggests there is a kernel of truth in this.

That's why the California budget crisis may well lead to a second financial calamity that would be far worse than anything experienced over the past 18 months.

California is, of course, facing a debacle. Voters rejected a series of ballot initiatives designed to restore some sense of sanity to the state's budget. As a result, California is more than $21 billion in the hole.

Governor Arnold Schwarzenegger is struggling to find enough spending reductions to close the gap, but investors are skeptical. According to Fitch Ratings, which in March downgraded California's general obligation bond rating, California has the worst rating of any state.

Even amid economic calamity, the people of California are relatively wealthy, and the state's economy is an impressive engine. If California were a country, it would have the eighth- largest economy on Earth. Given those advantages, the notion that California might default on its government debt might seem farfetched. After all, the reasoning goes, they can always raise taxes to pay off debt. Even a gridlocked legislature might act if California gets too close to the edge.

The problem with that line of thinking is that California's politicians might get little notice that desperate times are at hand. For some borrowers, the first sign of problem is their inability to make an interest payment. For others -- and here lies the nightmare scenario -- the problem first becomes visible when all the lenders disappear.

Lenders' Response

Imagine, for example, that California returns to credit markets in the coming months simply to roll over some of its expiring debt. Maybe the state borrowed money from China for two years back in 2007 and now has to borrow again to give the Chinese their money back. What happens if, seeing the catastrophic budget situation, lenders decide to shun California altogether?

If that happens, California would have to default on its obligation to give the Chinese their money back. It might do so by extending the terms of the existing debt, but that would be, nonetheless, a default, and a run on California debt surely could ensue.

Once a panic occurs, similar assets tend to be swept up in the wave. Bad news spreads. Witness the run that occurred during the Asian financial crisis of the late 1990s.

So if the unofficial eighth-largest economy fails on its debt, might the debt for the largest economy go with it? [Yes]

Deficit and GDP

A look at President Barack Obama's budget suggests that the U.S. government's fiscal situation is in worse shape than California's. [True]

The deficit relative to gross domestic product for the entire U.S. this year is 12.9 percent, according to White House estimates released last month. If California had the same deficit relative to its GDP, it would be short about $230 billion -- 10 times the size of its current shortfall.

What's worse, the Obama administration's attitude toward economic policy comes right out of the California playbook.

Notwithstanding White House claims that the federal deficit will drop to 8.5 percent of GDP next year, there is little cause to believe that the U.S. faces a brighter future than California. That shouldn't come as a surprise.

The Democrats have controlled the California legislature for most of the past four decades. In spite of protestations by the occasional powerless Republican governor, the Democrats adopted economic policies that define left-wing nirvana.

Top Tax Rate

Roughly 40 percent of California's income-tax revenue comes from the much-harped-upon top 1 percent of earners. Thanks in part to the "millionaire tax" approved by voters in 2004, California's income-tax rate has reached 10.55 percent on the highest earnings -- second only to Obama's native Hawaii, which taxes some income at 11 percent.

High tax rates on individuals, of course, hit many small businesses hard. If you wonder why the California economy is going so much worse than most of the country, this is a good place to start.

California has to answer for its treatment of corporations as well, socking them with an income-tax rate that is just shy of 9 percent. Since the U.S. federal rate is so high relative to our trading partners, corporations that operate in California face a combined local and federal tax rate higher than that of any other country. (Japan is a distant second.)

In case you wondered, California's sales tax is high, too. Most places in California, the combined city and state sales tax rate is more than 8 percent.

California is in crisis because state spending is so high that even those hefty taxes aren't enough to balance the budget.

California in D.C.

Except for the sales tax, the Obama administration's plan is to copy California's policies.

Obama has proposed a massive tax increase on U.S. corporations by curbing the deferral of taxes on corporate income earned abroad. He also has advocated higher marginal tax rates on the rich, by letting George W. Bush's tax cuts expire.

Even with those tax hikes, Obama projects that deficits are here to stay because, like California's Democrats, Washington's can't resist increasing government spending.

It is easy to see how investors might stop believing in California. If they do, it would be rational for the U.S. to be next.

Reuters reports that California to eliminate funds for recent contracts.

California to eliminate funds for recent contracts
Mon Jun 8, 2009 5:24pm EDT

* Order comes as California's cash dwindles
* California to "scrutinize how every penny is spent"
* State buys about $9 billion in goods, services each year

By Jim Christie

SAN FRANCISCO, June 8 (Reuters) - California Gov. Arnold Schwarzenegger, facing a state budget gap of $24.3 billion, on Monday ordered a halt to funding for state contracts on everything from pencils to office space.

His order applies to all contracts signed since March 1, excluding those for public safety, and ba rs new contracts. Projects funded by bonds and federal stimulus dollars are also exempt.

The state is expecting the move to generate savings of $1.35 billion, said Amanda Fulkerson, a spokeswoman for California's State and Consumer Services Agency, which oversees the state's contracting and purchases.

California's state agencies and departments on average spend about $9 billion each year on goods and services. In the current fiscal year, California entered into 36,498 contracts for goods and services from a variety of companies, including law firms, fuel and computer software providers and consultants of various kinds.

The state's revenues have plummeted during the economic recession, forcing state officials to consider drastic spending cuts, including to services and supplies, to balance the state's books, said Fulkerson.

"We have to look across the board for savings," she said. "The state controller has been very honest with us in talking about the state running out of cash in two weeks."

Schwarzenegger said the state would be tightfisted in its financial crisis -- and beyond.

"With today's action, every state agency and department will scrutinize how every penny is spent on contracts to make sure the state is getting the best deal for every taxpayer dollar," Schwarzenegger said in a statement.

STATE NEEDS TO 'DIAL BACK'

Schwarzenegger, a Republican, has ruled out tax increases to help fill California's budget shortfall, and the Democrat-led legislature is bracing to slash spending ahead of the July 1 start of the state's next fiscal year.

Schwarzenegger also wants to restrain future state spending. His order directs state departments to submit to the Department of Finance plans to cut their future spending on contracts and purchases by at least 15 percent no later than 30 days after the state's 2009-2010 budget becomes law.

"Regardless of the fiscal situation, they need to dial back," said Schwarzenegger spokesman Aaron McLear. "From our standpoint, every California household and business is cutting spending as much as possible. We need to do the same in state government."

Schwarzenegger's order comes amid rising concern over California's finances on Wall Street, which has given the state the lowest general obligation debt rating of any U.S. state.

"It's a reflection of the difficulty the state is in," said Emily Raimes, a senior at Moody's Investors Service.

"At this point everyone is anticipating big cuts," Raimes added. "It's just a matter of what the legislature can agree to cut and by how much."

Fitch Ratings last month warned it may lower California's 'A' long-term general obligation debt rating, which would likely push the state's borrowing costs up.

Fitch revised its rating outlook on California to negative from stable
[US credit ratings are a joke, and, if Fitch is revising California 'A' rating, then things must be really bad], noting in a statement that it has growing concerns about the state's budget gap and its dwindling cash. Fitch also said the state's numerous fiscal and cash-flow challenges through the coming budget year are key credit concerns.

My reaction: As Kevin Hassett writes, "The California budget crisis may well lead to a second financial calamity that would be far worse than anything experienced over the past 18 months."

1) California is more than $24.3 billion in the hole.

2) On Monday, California Gov. Arnold Schwarzenegger ordered a halt to funding for state contracts on everything from pencils to office space.

3) California's state controller has warned about the state running out of cash in two weeks (this warning happened last week).

4) The likely scenario (also the nightmare scenario) is that all California's lenders disappear, and the state is unable to roll over its debt.

5) If the unofficial eighth-largest economy fails on its debt, it will cast doubt on all government debt, especially treasuries.

6) The US government's fiscal situation is in worse shape than California's.


Conclusion: The 'bad' phase of the financial crisis is on the verge of beginning. It involves the dollar's collapse, soaring commodities, and skyrocketing interest rates.

The time frame for everything to really start falling apart is the next two or three months. California budget crisis is one of many factors which sets this time frame (default is likely within three months). A default by California would drag the bond market into the abyss.

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16 Responses to *****California Leads Nation to Bond Default Abyss*****

  1. SPECTRE of Deflation says:

    CA politicians need to get their heads out of their arses concerning the budget. Raising taxes is not the answer you idiots. Time to tighten the belt like never before bafoons, or your state goes boom in the municipal bond market. In fact it's already too late, but we are dealing with perception and not reality. The other 46 states and the Federal Govt. are in the same shape as well, and will join CA in the melt down. Prepare for the uglyness now and beat the crowd.

  2. What would a balanced budget look like? Fire teachers, cops, prison guards, cut medical expenses by closing hospitals and firing doctors.

  3. dashxdr says:

    Whoa there, "SPECTRE of Deflation".

    There is a bigger picture you need to see here. The goal isn't to prolongue and maintain a corrupt system. Making band-aid fixes (drastic cuts to spending) would leave the corrupt politicians in place. You're recommending a matter of cutting back the cancer, but leaving some still there.

    You can buy a little time, perhaps, but then the cancer will grow again.

    Solution? Let the system die. Embrace the end of the US Empire. Embrace California socialism failing completely.

    It's the only way to end the corruption.

  4. VegasBD says:

    dash-

    agreed. i am embracing it. the end of the great liberal socialist trial in the US they call california. hell, i LIVE HERE and im happy its happening. i make six figures but i kind of want to get laid off so i can say someday that i helped BK this state!

  5. Anonymous says:

    You should choose where you face the End because one place is as good as any other.

  6. Anonymous says:

    @all

    If this article is read from a German perspective, one can only ask: Why do you not increase taxes (as they are very low in CA)?

    In Germany sales taxes is 19%, with no circumvention whatsoever.

    A single person, income in the 55-60K range, pays approx. 50% of the income for taxes, mandatory retirement, health and unemployment insurance. At least health and retirement systems are still quite o.k. Families pay less of their income and get additional benefits. If you earn 6 digits euro you can circumvent a lot of that stuff, so the tax and social system cross financing burden is primarily taken by the large group of mid-income earners.

    Whereas this system is outstretched to the max. and ready to collapse, there might be a lot of room in the US to raise taxes and state income - at least from a central european perspective.

  7. OperationNorthwoods says:

    Anon,

    You get something for your taxes in Germany. Also, so many people are on the edge as it is, that raising taxes would put them over the cliff. That, and there's already a lot of people and businesses leaving the state as it is no longer Golden.

  8. Anonymous says:

    Left Cali in 2005 because I saw what was coming... didn't quite think it would take almost 4 years and hadn't a clue it was going to be the entire world.. but I'm so glad to NOT be there

  9. Anonymous says:

    @ anonymous
    Ca taxes, health etc are more than 50%
    the 10.5% is only for ca income tax add another 28% for federal taxes, 9% for SS and medicare, haelth insurance if you can get it is close to 1k/mo for 2 and then we have our sales tax which is now over 10% in L.A.

  10. Anonymous says:

    @ anonymous.AND don't forget property taxes, cell phone taxes, gas tax, vehicle tax and lots more hidden taxes.
    we voted down down any more taxes-it all goes to bureaucrats and welfare, govt. pensions,uninsured and illegal residents' health insurance. Can we send some pregnant undocumented aliens to Germany to have their children???? Feed them educate them and then let their parents in for the free ride. all the govt workers are still unionized and get their pay/benefits protected not so for anyone in the private sector-we've all taken a big haircut-now it's their turn.

  11. Anonymous says:

    Everybody knows they need to cut back on the bloated govt employment. You've got 27 govt employees doing the work of one teenager. School administrators, prison employees guarding former marijauna users.

    Millions of people who were promoted and put at desks doing nothing because they were incompetent.

    The sooner it implodes the better.

  12. Lawrence says:

    Anybody with half a brain saw this coming a mile off. Get out of USA while you still can. There's only one way this is ending. Badly!

  13. Anonymous says:

    I find this discussion to be lacking in depth with regards to the very likley response of the the urban citizen response to no goverment services.
    And that is putting it very mild as the watts riots will be seen as a picnic compared to the destruction that is comming.
    Rulers have alwaysfeared the publics ability to take from the rich and little armies are never prepared for domestic war.
    Tax increases are a cheap way out to keep control of a desperate populaus.

  14. paokano says:

    I still haven't heard any CA politicians seriously discuss eliminating illegal immigrants and their tremendous cost the CA economy. Until CA gets serious about illegals, it is not serious about fixing its economic debacle.

    You CA citizens are getting what you have voted for....years and years of a free-spending liberal governments that spend and spend with no regard for the future. Why are you complaining-you keep voting these guys in.

  15. paokano says:

    CA citizens: STOP COMPLAINING! You are getting what you have voted for year after year after year: the same free-spending liberal politicians in a one-party state.

    And now you wonder how you got into the deficits you are in? Wake up and vote the clowns out of office, and start over with some common sense. They can start by solving the economic drag from illegal immigrants. If you cannot do that, you are not serious about improving the lot of real citizens.

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