I was asked to comment on California's budget predicament. The state has just started issuing IOUs to its suppliers - not exactly a reassuring sign for a borrower that still sports an A/A-/A2 rating for its GO bonds from the major rating agencies.
SAN FRANCISCO (Reuters) - California's lawmakers failed to agree on a balanced budget by the start of its new fiscal year on Wednesday morning, clearing the way to suspend payments owed to the state's vendors and local agencies, who instead will get "IOU" notes promising payment.
Just about every financial spin-master I have read places the blame on government inefficiency, gerrymandering, etc. In other words, they say this is politics as usual - if a bit less so given the current depth of the economic crisis. No one seriously considers the possibility of default, assuming the federal government will be forced to bail out the country's most populous and economically important state. After all, if California was a country it would have the eighth largest GDP in the world.
But.. California in NOT a country, it does NOT have its own central bank and it does NOT issue dollars. It issues bonds priced in dollars, which is an entirely different matter. In that, it resembles Argentina back in the 1990s when it hard-pegged its currency to the US dollar, with disastrous results.
What matters, then, is how the real economy is doing in California. Two charts:
- For the three major metro areas in CA, home prices are off 43% from the top reached three years ago. Home prices are crucial because local governments derive a big part of their revenue from real estate taxes.
CA Home Prices Off 43% From The Top
- Unemployment is soaring in California. It just touched 11.5% in May, the highest rate in at least 33 years. Payroll and income taxes are collapsing.
Chart: FRB St. Louis
Quite obviously, then, the budget crisis in California is fundamental in nature; it's not a party-politics stand-off to score points with the voters. It won't be easily fixed in a (non-smoking, surely) back room where deals are cut and backs are slapped. This is REAL and is happening in real-time.
Default probability? Certainly a whole lot higher than the A/A-/A2 ratings would suggest.
- Addition: It is instructive to consider facts with all political baloney stripped away. California's general fund revenues are around $100 billion and are derived as follows: 50% personal income tax, 35% sales tax, 10% corporate income tax (see table below, click to enlarge).
Source: CA Governor's 2009-10 Budget
The current budget deficit is projected at $26.5 billion, i.e. 26.5% of revenue. No further discussion necessary..