California Isn’t Going to Default

All week long, comments by financial analyst Chris Whalen – where he predicts California will “default” – have been getting a lot of traction:

Whalen thinks that California will default on its debt–hammering all the pension funds and other investors who have loaded up on apparently safe state bonds.

The state won’t immediately default, Whalen says.  It will start by issuing the same sort of IOUs that it issued to by itself time during its budget crisis last year.  But, eventually, the debts will have to be restructured, and this will result in those who own California’s bonds receiving less than 100 cents on the dollar.

Why won’t California just get a bailout?

Because the Republicans now control Congress, Whalen says.

Whalen’s sleight of hand here is obvious if you know what you’re looking for. Yes, California may have to issue more IOUs. But that doesn’t necessarily mean the state will default, or have to restructure its debt. Whalen apparently doesn’t know (or chooses to ignore) the fact that California cannot default on its debts – bondholders are constitutionally guaranteed payment, second only to public schools in their claim on the state treasury.

Whalen might just be talking down California bonds so that he can force Bill Lockyer to sell at a higher interest rate. His cluelessness about the state’s inability to default certainly calls into question his analytical skill. And yet he is right that the Republican House of Representatives will happily tell California to drop dead – especially since they and the rest of the right-wing are convinced that California is subsidized by the rest of the country, when in fact it’s the other way around:

During the November 16 episode of Varney & Co. on Fox Business, Varney interviewed Gov. Arnold Schwarzenegger’s Press Secretary Aaron McLear about Schwarzenegger’s current efforts to balance California’s budget. He asked McLear if he would take a pledge to “not take one more dime from federal taxpayer money going to California.” Then he continues: “You guys in California, you’ve been making fun of…the hicks who live in the Midwest…you’ve been making fun of them. Now you want their money.”

Incensed, McLear told Varney that “[California is] what is called a donor state. We get less on every dollar back from the federal government than any other state. States like Mississippi and Alaska get more back from the federal government for every dollar they spend.”

McLear is right.

Notice how the right-wing frames California’s fiscal problems: we somehow screwed up, and now we want other people’s money to bail us out, even though we are still a donor state. In short, if CA did want a bailout, we’d merely be asking for our money back instead of subsidizing red states. And of course, there’s no mention of the fact that California’s economic problems stem from decisions made by a president this state did not elect, by a Congress where our representatives were in the minority.

In other words, Republicans want to treat California like a colony.

There is no doubt that the state’s budget situation is still dire, as the New York Times’ Adam Nagourney writes today. Much of the article is familiar to those of us who have followed the ongoing state budget crisis, but it does break new ground by offering some insight on how the deficit might be addressed in the new year – and with a new governor:

Mr. Steinberg said that given all the restrictions the state faced, the best course of action would be a realignment of state services in a way that would require local governments – which might have more flexibility to raise some taxes – to provide them. He said he thought Mr. Brown would be more receptive to that kind of revamping than Mr. Schwarzenegger.

“I think the notion of trying to raise state taxes to continue to prop up this system is a dead end,” Mr. Steinberg said, adding, “Unless we get the miracle of an economic recovery faster than anyone expects, we have to be bold.”

In fact, as the recent PPIC poll showed, Californians are willing to pay more taxes for public services – in this case, higher education. More on that poll later today, but for now, it shows that if the new governor and the Democratic legislature can make the case for government, Californians might just be willing to support new taxes in a 2011 special election.

Instead, Steinberg is signaling that Sacramento might wind up devolving more programs to cities and counties, potentially with the authority to raise money to fund them. Prop 26, Prop 218, and of course Prop 13 itself limit significantly the ability of local governments to provide basic services, which is why Jerry Brown helped set up the Sacramento-centric system to fund those services 30 years ago.

This also raises major questions about equity and fairness – the problem encountered in the 1970s was that cities like Beverly Hills were able to spend a lot on schools, whereas poorer cities like Salinas couldn’t. How Sacramento plans to get around the Serrano decisions is entirely unclear, but it’s going to have to be dealt with.

California isn’t going to default. But we still face a serious budget crisis that will not be resolved until we fix our state’s broken system of government, and enable the majority to once again rule. Prop 25 was a start. But all 2/3 rules have to be abolished before we can have a hope of balanced budgets, strong public services, and economic recovery.

8 thoughts on “California Isn’t Going to Default”

  1. But that LA Times cover story has me running for cover. There’s no public interest in taxes going up. None at all.  And it doesn’t look good for a Government bailout either.

    Here’s my question that will rightfully define me as a newbie. What happens if we default? Can we rewrite the Constitution finally?

  2. California has to issue IOUs when the budget is hugely late.  But for the next couple of years, we have a Democratic legislature and a Democratic governor, and the 2/3 rule is gone; the Republicans have no say at all about the budget.  There will still be battles, and money will still be tight, but the hostage-taking will be over.

  3. Most people, I think don’t view the 2/3 majorities required in various context as a major hurdle. Instead of 50%, you need 66%…that’s more, but not a whole lot more, right?


    A 2/3 majority is a two-to-one majority. And most people, if you put it that way, recognize just how undemocratic it is to demand for 2 votes for to outweigh one vote against something.

    Or put it in sports terms: Braves Defeat Dodgers, 7-13! Wait, that doesn’t seem right? Well, it does if baseball required a 2/3 victory margin!

  4. In matters of finance, I tend to think the finance guys may know something the history guys don’t.

    Yes, the bondholders are “protected”… as were the General Motors bondholders (until they were wiped out).  NYC defaulted a few decades ago and so could California now.

    I thought this post was going to argue FOR a default.  After all, a Federal bailout is not going to happen and any more cutting of services would be so backwards-moving as to make us sick (maybe literally).  The holders of California’s debt tend to be Californians (to take advantage of the tax advantages)… but they also tend to be the rich (who want tax advantages).  A state default would most impact the rich and therefore have an impact of sticking the financial mess on the wealthy.  With it so hard to pass a tax increase, is this an end-around.. even with collateral damage?

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