Is California Too Big To Fail?
Preliminary returns on Tuesday night show that voters soundly rejected ballot measures calling for higher taxes, meaning that the not-so-Golden State’s politicians are likely to take hat in hand and head to Washington begging for a bailout.
Republican Gov. Arnold Schwarzenegger floated that idea months ago, as did Assembly Speaker Karen Bass, a Democrat. Schwarzenegger’s visit to the White House on Tuesday surely didn’t harm its prospects.
California does have enough cash to survive through June 30, but the state controller estimated in March that another $10.6 billion would be necessary to last the summer.
A more recent report from the state’s non-partisan Legislative Analyst’s Office offers a higher estimate of what would be needed if the ballot measures failed. It says: “Failure of measures in the May 19 special election would increase the state’s cash flow pressures substantially – potentially increasing the short-term borrowing requirement to well over $20 billion. California is likely to have difficulty borrowing anywhere close to the needed amounts from the short-term bond markets based on the state government’s own credit.”
Ouch. To sum up: Legislators can’t easily raise taxes (because of a requirement for a two-thirds supermajority). The Democratic majority is unwilling to go along with serious budget cuts. That leaves capital markets.
But who wants to lend to a debtor with such a bleak future? In February, Standard & Poor’s awarded California the dubious honor of having the worst credit rating of any state.
Schwarzenegger has proposed attempting to raise $6 billion by handing lenders what are known as revenue anticipation warrants – the rough equivalent of a subprime loan – but that means the state will pay Wall Street dearly in the form of additional fees and interest. Besides, $6 billion is hardly enough to cover the state’s looming budget deficit.
Which is why left-coast politicos are hoping their right-coast counterparts will prove to be an easier mark. Last week, Treasurer Bill Lockyer asked U.S. Treasury Secretary Timothy Geithner for a bailout through the TARP program, which was created to help ailing banks. “I am writing today to ask that you authorize extending TARP assistance to the State of California and other financially strapped states and local governments which face a severe cash flow crunch in the near term due to eroding tax revenues resulting from the current economic downturn,” Lockyer wrote in his letter.
Other options include federal guarantees for loans that California takes out – the equivalent of having a co-signer – or a commitment from the U.S. Treasury to buy those loans. A third choice would be funneling stimulus funds to the state faster than scheduled.
An article in Tuesday’s Bond Buyer newspaper reported, citing congressional sources, that the U.S. Treasury and Federal Reserve are considering loan guarantees and “other assistance” to state governments. A House of Representatives committee is holding a hearing Thursday on a bill to provide federal guarantees; House Speaker Nancy Pelosi, a San Francisco Democrat, is in a position to make that happen.
Now, it’s true that California’s fiscal woes are serious, but they’re the result of politicians’ poor decisions over many years. No matter how it’s concealed, a bailout could jeopardize the nation’s AAA credit rating – and invite 49 other governors to queue up outside the Treasury building. (The incentive is perverse: The worse shape your state is in, the more cash you get from the Feds.)
Between the 2004 and 2008 fiscal years, total state spending increased by around 44 percent, far outstripping tax revenues. Debt has tripled in six years. All this is true even though Californians enjoy one of the heaviest income tax burdens in the nation.
There was “a pronounced run-up in spending in the four years preceding the recession,” says Jason Clemens, director of research at the free-market Pacific Research Institute in San Francisco. “Secondly, the base from which the state is trying to draw revenue is shrinking. People are voting with their feet. Businesses are leaving the state, as are citizens.”
Not helping is that neither Schwarzenegger nor Democrats in the legislature are willing to confront public employee unions, including teacher’s unions that enjoy the highest pay anywhere in the country. The Obama administration’s insistence on putting demands of the Service Employees International Union, which opposed California wage cuts for home health care workers, is no better.
“Political leaders have said we can have high tax rates, we can have fairly high government spending, and we can have a robust economy,” Clemens says. “The economics behind that are just faulty.”
So might be the assumption that Washington, D.C. will write a blank check, and that any bailouts will limited to California. One estimate says 47 states are suffering declining revenues, meaning just about everyone’s a candidate for a federal handout.
It will be interesting to watch Senate Majority Leader Harry Reid, a Nevada Democrat, explain to his conservative constituents why Sin City taxpayers need to bail out San Franciscans. It will be even more interesting to watch what the Golden State does if the Feds say no.