Economist Looks at the California Disaster

California spends more then it should. I know that is stating the obvious but apparently the political machine that lives in Sacramento doesn't recognize this. The collapse of the states finances has led to the of issuing I.O.U's and the downgrading of the states credit. Lets cure some myths about the collapse before we go any further, this is not simply a case of the people of California demanding services without having to pay for them. A better case could be made that various constituencies, primarily unions, refuse to give an inch. These groups provide the votes, manpower, and money that insure easy re-elections for politicians in power. Its a great system if you are part of it, the Unions have their perks protected and the politicians can't lose. Of course when the revenues dry up a choice is supposed to get made, cut or increase revenues. Increasing taxes will not solve Californians problems and the lefts argument that the conditional rules where 2/3rds of the government must agree to raise taxes is a false argument designed to ignore the reality that California represents a fiscal disaster Obama and his allies are trying to emulate on a national level. The failure of constitutional gimmicks and the refusal of the Democrats and Unions to face reality have put the state in limbo and as of now very little reason to be optimistic.

From the Economist:

ALTHOUGH one would hardly know it from the antics of its politicians—or from its newspapers, which all this week were fixating on Michael Jackson’s funeral rites—California is in as serious a condition as an American state can be. Legally unable to declare bankruptcy as a company would, the state has begun paying many of its bills with IOUs instead of cash. One of the three big credit-rating agencies, Fitch, this week downgraded the state’s bonds, already the lowest-rated such bonds in the country, to BBB, within spitting distance of “junk”. Government offices are closed on some days, as state workers take involuntary and unpaid furloughs. Taxpayers are still waiting for refunds. Poor people are afraid of losing their state-funded health insurance. Parents, fearing ever shabbier public schools, have another reason to think about moving out of state.

Meanwhile, the governor, Arnold Schwarzenegger, and the leaders of the legislature have been frantically scoring points off each other in Sacramento, the state capital. As the previous fiscal year drew to a close on June 30th, Darrell Steinberg, the Democratic leader of the Senate, and Karen Bass, the Democratic leader of the Assembly, were proposing some stopgap measures that would have saved a dollop in the new fiscal year and averted the issuing of IOUs. But the Republican governor, claiming to insist on all or nothing, said no. Overnight, the budget gap swelled to a staggering $26.3 billion and now grows by an estimated $25m each day.

The cow tails was a nice touch, but such stupidity is common on a state and local level where small organized groups have there pet issues pushed by politicians. Of course California itself is divided between the coastal areas who push environmental rules and animal rights nonsense on the agricultural areas of the state, essentially imposing their values on farmers and businesses.

So who suffers:

With luck the IOUs, officially called “registered warrants”, will turn out to be more symbolic than apocalyptic, provided that banks accept them and that a budget deal arrives soon. The last time California paid with IOUs, in 1992, Bank of America was dominant in the state and kept order. This time many banks must play along, and several suggested this week that they would accept the IOUs only until July 10th. If that practice becomes widespread, bearers may have to wait until October to get their money. For some suppliers this may mean bankruptcy; for students, uncertainty over their college tuition; for consumers without tax refunds, austerity.

And if all this leads to more downgrades, California’s borrowing costs will increase and the budget gap will further widen. But this does not automatically threaten the owners of California’s “muni” bonds, since the state constitution dictates that schools be paid first, bondholders second and then everybody else.

In California two of the most powerful Unions are the corrections officers and the teachers unions who are bitterly opposed to any cuts. That is all well and good but if the state is collapsing you would think modest cuts now makes more sense then larger cuts later. Every day this goes on the budget gets harder to fix, and if the muni-bonds are downgraded by other agencies besides Fitch it will lead to increase borrowing costs, meaning greater cuts to fix the budget. The elected Democrats and the Unions know this, and for too long deluded themselves into thinking tax increases were the solution and only just recently backed off on the issue. More likely they are still counting on Obama and the Federal government bailing out the state to prevent further cuts to groups that provide donations and political support to the Democratic party. This is a dangerous game as a Federal bailout is unlikely considering the adamant opposition from the public at large for such a move. Of course much of the first stimulus was turned into a state-level bailout anyway as various local governments papered over their deficits with money that was designed to generate growth, the stimulus disaster and the corresponding job losses it it caused have undermined a significant amount of Obama's credibility and make any push by the President to bailout the state highly unlikely. Of course Obama used the stimulus money to bully California, but that is a separate issue. With little hope of a compromise the article sums things up rather well:

The pain thus seems likely to flow to the bottom of the social hierarchy. But all Californians will notice. Their parks may close, their neighbourhoods may become less safe. “The Californian Dream is at least temporarily suspended,” says Mr DeVol.(Chief economist at the Milken Institute, a think-tank in Santa Monica)

It would be derelict not to offer some solutions, so here its goes:

1. Open up the coast to offshore drilling and the use a revenue sharing formula between the state and federal governments with the royalties.
2. Modest cuts along with furloughs and early retirements to ease the payroll burdens.
3. Scrap as many inane regulations about the environment and animal rights that stifle economic growth. Does this mean get rid of all of them, of course not but a certain level of rational thought should be applied.

A small start, but everything on that list could be done and would reduce the human cost to solving the fiscal disaster.