As we prepare for the inevitable yet welcome defeat of at least 5 of the 6 propositions on today’s ballot (come on No on 1F!) talk is growing of federal aid for California’s budget mess. Of course, had the US Senate not gutted the state stabilization funds in the stimulus bill we might not be in this mess, but hey, Olympia Snowe and Arlen Specter had to be appeased! Ezra Klein, himself an Orange County native, offered his take on a “bailout”:

As a Californian, I find this argument comforting. But as a Californian, I find the need for this argument extremely troubling.

California, which like many other state and local governments is still experiencing extreme budget problems, has an economy larger than all but about 10 countries. Even without the actions that the federal government has already taken to provide corporate bailouts, there is little likelihood that Washington, D.C., could or will allow a default in the municipal bond market to occur in the current economic and financial environment. In fact, through the stimulus bill and other actions, the federal government has already taken a number of steps to make that less likely.

…That said, a lot of companies that proved too big to fail weren’t too big to change. Wall Street was given compensation caps. GM had to renegotiate its labor contracts. If Washington is going to bail out the Golden State, it should make the money contingent on structural reforms that leave the state better able to balance budgets in the future. This should be like an IMF intervention (maybe Simon Johnson has some thoughts?).

California’s legislature is in a strange position: It needs a two-thirds vote to raise taxes but also has to fund ballot propositions that require a simple majority of an uninterested public. The majority party in the legislature, in other words, can neither control how much money it raises nor how much money it spends. That’s not a sustainable state of affairs.

As I’ve been writing about here at Calitics recently, this is not a far-fetched possibility. It is entirely possible that DC could use this as leverage to force Arnold to accept a majority vote budget. There’s no legal way for the federal government to force our Constitution to change, but as with most forms of federalism post-1933, the power of the purse is usually sufficient.

What concerns me much more is Ezra’s comment “this should be like an IMF intervention.” The sad irony is “IMF interventions” themselves were invented to deal with a default of an American government – in this case New York City in 1975. Lots of folks remember Gerald Ford’s famous “Ford to City: Drop Dead” moment where he refused a federal bailout for NYC. Few know the follow-up to that story, where the bondholders took Milton Friedman’s theories for a test drive. They demanded and received massive cuts to social services in exchange for renegotiating the city’s debt. The successful model was then used on Mexico, Argentina, and many other countries.

We’ve seen workers crammed down in the auto bailout and seen homeowners get screwed in the bank bailout. I am not confident that a federal bailout of CA would avoid similarly nasty outcomes.

From what I can tell the most likely outcome is something less than an outright “bailout” that could stabilize things for a little while, but not solve the deeper problem. Congress is likely to come up with some solution by which the Treasury backs California’s short-term Revenue Anticipation Notes. That might be enough to avert a near-term cash crisis. It won’t be enough to right the ship.

Of equal importance is the upcoming fight over the stimulus rules. It is critically important that the Obama Administration refuse to bend those rules. Republicans are already demanding that we be given a waiver from the rules in order to make massive cuts to social services and education, cuts that were forbade as a condition of accepting the stimulus.

Otherwise Arnold Schwarzenegger’s efforts to play the role of Fernando de la Rúa will come to fruition. And that’s the last thing we want.