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post #1 of 6 (permalink) Old 06-01-2009, 11:19 AM Thread Starter
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California Leads Nation to Bond Default Abyss

California Leads Nation to Bond Default Abyss: Kevin Hassett
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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?

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.

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.
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post #2 of 6 (permalink) Old 06-01-2009, 11:51 AM
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California has only one REALISTIC and SANE option. Cut Spending Drastically and do it immediately. Kill every social program. Kill everything they can't afford and don't absolutely need. If they did that, I bet they would have the money to pay for police and schools.

But words like Realistic and Sane are not part of the equation in California. So I predict a total cluster fuck will occur.

But look on the bright side. A lot of those California based companies have been moving to Texas.
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post #3 of 6 (permalink) Old 06-01-2009, 01:33 PM
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And Nevada, and Arizona, etc etc. They are all getting out of there.

So this leads to the lesson of 'taxing those that provide jobs to the brink of bankruptcy and forcing them to leave, only leaves you with those that continue to suck up resources'

What would happen if China called the note(s) issued to the US? We obviously don't have the money to pay, so would it lead to war? Failure of the Chinese economy? What?

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post #4 of 6 (permalink) Old 06-01-2009, 01:40 PM
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Quote:
Originally Posted by Sgt Beavis View Post
California has only one REALISTIC and SANE option. Cut Spending Drastically and do it immediately. Kill every social program. Kill everything they can't afford and don't absolutely need. If they did that, I bet they would have the money to pay for police and schools.

But words like Realistic and Sane are not part of the equation in California. So I predict a total cluster fuck will occur.

But look on the bright side. A lot of those California based companies have been moving to Texas.
Probably wouldn't need to pull the social programs...just give it to the legal U.S. of A. citizens!

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post #5 of 6 (permalink) Old 06-01-2009, 02:05 PM
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Quote:
Originally Posted by Sgt Beavis View Post
California has only one REALISTIC and SANE option. Cut Spending Drastically and do it immediately. Kill every social program. Kill everything they can't afford and don't absolutely need. If they did that, I bet they would have the money to pay for police and schools.

But words like Realistic and Sane are not part of the equation in California. So I predict a total cluster fuck will occur.

But look on the bright side. A lot of those California based companies have been moving to Texas.
That's what the voters out here tried to do - send a message to sacramento about the governments spending. Of all of the tax measures on the ballot the one that passed cancels raises on salaries to legislators when there is a budget deficit LOL.....

Will the politicians hear? IMO doubtful. Until the pain becomes unbearable.

I believe that the same situation waits for the federal government.

Whats the common denominator? democrats in charge. tax and spend!
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post #6 of 6 (permalink) Old 06-01-2009, 06:43 PM
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I thought TX singularly had the 8th largest economy in the world...?

Facts?



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