The continuing crisis in California

From The Economist:

ARNOLD SCHWARZENEGGER was skiing in Idaho when his office released a detailed outline of California’s 2009-10 budget. It would be unfair to suggest that the governor is unconcerned about the state’s dire fiscal situation. On the contrary, he has tried to focus minds on it for months. But the episode does, perhaps, hint at how seriously he expects his proposed solution to be taken.

California, first in many things, is facing America’s worst budget crisis. The gap between projected revenues and spending during this fiscal year and next amounts to $41.6 billion, which is almost half the total sum that the state expects to raise next year. Unlike the federal government, California is not allowed to get out of the jam by running a deficit. It is finding it hard to borrow to meet even short-term needs. Infrastructure work has virtually stopped. If nothing is done to close the gap soon—and perhaps even if it is—the state will begin issuing IOUs as early as next month.

Recession triggered the crisis but did not cause it. California relies heavily on income taxes, especially those paid by the top 1% of earners. These veer up and down with the markets. But instead of saving money in boom years, the state locks in higher spending on public services and embarks on projects that need long-term investment. Dave Cogdill, head of the Republicans in the state Senate, likens it to a family that adopts children in good times, only to find that it cannot afford to feed them when the economy sours.

Mr Schwarzenegger’s solution, which he will describe in detail later this week, combines swingeing spending cuts (even to normally inviolable schools) and equally swingeing tax increases. He wants to lift the sales tax by 1.5% until 2012. This would take it to between 8.75% and 10.25%, depending on where one is in the state. Although painful, the governor’s proposed budget is still rather optimistic. It assumes, for example, that federal spending on infrastructure will jump, that the cost of fighting fires will be less than half of what it was this year, and that the state will be able to sell $5 billion in bonds by July.

The plan anyway faces crippling opposition in the state Capitol. The Democrats who dominate both houses of the legislature find deep cuts to education and health care unpalatable. The Republicans, who can muster enough votes to block the governor’s budget, refuse to consider tax increases unless they are accompanied by a root-and-branch overhaul of state finances and a mass sell-off of state assets. The divide between the two camps is as wide as Yosemite Valley.

More on California fiscal crisis

From the Financial Times:

SAN FRANCISCO, Dec 19 - California Governor Arnold Schwarzenegger declared a fiscal emergency on Friday to call lawmakers into another special session to tackle the state’s weakening finances, and separately ordered state officials to prepare to furlough and lay off employees to cut costs.

His two actions mark a dramatic escalation in the budget battle waged in recent weeks in Sacramento, the capital of the most populous US state and world’s eighth-largest economy, as its revenues fall harder and faster than expected.

California’s state government now faces a $40 billion budget shortfall over its current and next fiscal years and is on track to run out of cash in February.

California’s Democrat-led legislature concluded its prior special session on Thursday by approving an $18 billion budget package, but Schwarzenegger, a Republican, said he would veto it because he wants lawmakers to both address the state’s budget gap and ease regulations to speed construction projects to help stimulate the state’s economy.

Assembly Speaker Karen Bass said the Democrats’ package would have provided for $3 billion in revenues for transportation projects, accelerated $3 billion in bonds for transportation projects and made it easier for hospital construction and expansion projects to move forward.

The dispute over which approach would better boost California’s ailing economy, underscored by its 8.4 per cent unemployment rate last month, comes on the heels of a decision on Wednesday by the state’s Pooled Money Investment Board to halt $3.8 billion in loans for public works.

The state government needs funds from the Pooled Money Investment Board to pay for vital services. The board’s action affects almost 2,000 projects, including highways, schools, levees, housing and parks.

The legislature now has 45 days to pass and send a bill or bills addressing the state budget to Schwarzenegger.

In the meantime, the state’s Department of Personnel Administration will under Schwarzenegger’s executive order adopt a plan that would go into effect in February to furlough state employees and supervisors for two days per month.

The order also calls for state agencies and departments to initiate layoffs and other ”program efficiency measures” to post savings of up to 10 per cent in the state’s general fund.

”Every California family and business has been forced to cut back during these difficult economic times and state government cannot be exempt from similar belt tightening,” a statement from Schwarzenegger office said.

Assembly Majority Leader Alberto Torrico and two other top Democratic lawmakers issued a statement that said Schwarzenegger’s order ”adds insult to injury for the state’s economy” and chided him for failing to win over either Democrats or Republican lawmakers to his budget plan.

”The governor has shown he can’t negotiate with Republicans, he doesn’t negotiate with Democrats, and now he’s refusing to negotiate with employees,” their statement said.

”It’s the same lack of leadership that has kept him from coming up with a single vote for any budget solution. And now that lack of leadership has resulted in his making a scapegoat of employees who are not the source of the problem.”

Still watching California

The issue of whether the US state of California will go the way of Iceland is still on the agenda.

THE state of California, one of the top 10 largest economies in the world, will run out of money by February, causing "financial Armageddon", according to dire new budget projections.

As of yesterday, the state's debts were mounting at a rate of $US1.7 million ($2.54 million) per hour.

The de facto insolvency of the US's most populous state - home to such economic engines as Silicon Valley, the Central Valley agricultural region, Hollywood, Napa Valley, the Long Beach ports, and the defence research and production facilities of Los Angeles, San Diego, and the Mojave Desert - would represent a new scale of catastrophe in a year that has seen financial markets and economies across the world implode.

Bill Lockyer, the Treasurer of California, has given warning that $US5 billion of public works projects, including road and school construction, will have to be cancelled because the state's lenders are worried about an impending Iceland-style bankruptcy. California - which has a GDP of $US1.7 trillion - already has the worst credit rating of any of the US's 50 states.

"Without a budget solution, state financing of infrastructure projects will stop. It's as simple, and dire, as that," Mr Lockyer said this week.

For California's Republican Governor Arnold Schwarzenegger, the crisis represents a humiliating final act to his second term. Mr Schwarzenegger, 61, came to power in 2003 because of an almost identical financial calamity, which resulted in his Democratic predecessor, Gray Davis, being "recalled" from office.

At the time Mr Schwarzenegger promised an end to California's tax-and-spend policies and runaway expenses, yet over the past four years of his administration the state's budget has grown by 40 per cent to $US144.5 billion. Thanks to the housing crash, recession and credit crunch, the state can no longer afford this with tax collection.

As the crisis continues and California's credit rating deteriorates, the cost to the state of borrowing keeps rising - a process that could ultimately cause the same kind of deadly spiral that this week tipped the Chicago-based publisher of the Los Angeles Times into bankruptcy.

Mr Schwarzenegger is proposing the same kind of emergency tax rises that in 2003 turned Mr Davis into a pariah. He has suggested a 1.5 per cent increase in sales tax - the equivalent of Britain's VAT - and a tripling of the car tax. When Mr Schwarzenegger first ran for office, he did so on a promise to a revoke a similar car tax increase proposed by his predecessor.

So far, however, Republicans in California's legislature have refused to go along with the proposals and Democrats have refused to cut government programmes, hence the stalemate.

Mr Schwarzenegger has declared a "fiscal emergency" to keep California's legislature in session until a solution can be found.

"When you have a crisis the most important thing is to make a decision," said a clearly frustrated Mr Schwarzenegger at a hastily called press conference on Wednesday. There, he presented an electronic display showing how much the deficit is growing in real time: $US470 per second, $US1.7 million per hour, and $US40 million per day.

He put it outside his office in Sacramento in an attempt to get the state's legislators to reach some kind of agreement. "The worst thing is not to make a decision," he said. "The most costly thing we can do is not to take any action."

California's biggest problem is the precipitous decline in tax revenues over the past year. The state's property taxes - the equivalent of Britain's council taxes - are based on the value of a house when it was first bought, and can then rise by no more than 2 per cent a year. This means that by far the most tax revenues come from new property sales, and these have all but dried up.

Adding to the problem is the fact that many homeowners who bought during the bubble years are now successfully appealing against their property taxes, using evidence that the value of their home is less than it was when they purchased it.

Tax revenues have also been hit by the global recession.

Clock still ticking in California

The world's sixth largest economy is still in danger of fiscal insolvency. The ramifications of California going the way of Iceland are pretty dire to contemplate.

With time and money running out for California, Gov. Arnold Schwarzenegger declared a fiscal emergency Monday and called legislators into a new special session that won't end until they agree on a way to trim the state's $11.2 billion budget deficit.

"Without immediate action, our state is headed for a fiscal disaster" in which California could run out of money to pay its bills by late February, the governor said in a news conference in Los Angeles.

He compared the growing deficit, which could reach $28 billion by 2010, to an avalanche gaining momentum, and he slammed the Legislature, Democrats and Republicans, for not coming up with solutions during a special session that ended Nov. 25.

"Unfortunately for California, the legislators did not seem to appreciate the severity of our crisis," Schwarzenegger said. "In an emergency like this, we have to take quick action to avoid even worse problems, even if they include decisions we don't like."

For more read here.

Watch California

As we go into the next phase of the financial crisis after the $840 billion bailout package was passed by the U.S. House of Representatives on 3 October, a few hints are emerging that one place to watch is California. The state has been struggling financially for some months with a deadlock on Governor Arnold Schwarzenegger's budget only just being resolevd, and it is the epicentre of the sub-prime mortgage crisis and house repossessions.

This story from MSNBC suggests that it may have troubles paying it state employees this month (picked up originally from Dollars and Sense):

Gov. Arnold Schwarzenegger and California's top finance officials reacted cautiously Friday to congressional approval of the $700 billion Wall Street bailout package.

They have been worried that the credit market will hurt the state's ability to get short-term loans to cover basic operating expenses, a step California takes each fall until the bulk of its tax revenue arrives in the spring.

Even with the bailout plan passing, Schwarzenegger predicted a difficult path ahead in the financial markets.

"California's not out of the woods yet," he said during a news conference in San Diego, noting that California soon will begin seeking loans on the open market. "It will be difficult. We will be going through challenges in the future."

He said he would convene a meeting on Wednesday with the four legislative leaders to discuss the state's financial situation.

While California seeks short-term loans every year, the situation is especially precarious this year because the nation's credit market has seized up under the strains of the housing-related economic meltdown and because state lawmakers delayed passing a budget for nearly three months.

The record-long budget impasse prevented the state from going to the bond market sooner.

On Thursday, Schwarzenegger sent a letter to Treasury Secretary Henry Paulson asking the federal government to protect California if the state is unable to secure financing for routine borrowing.

"Absent a clear resolution to this financial crisis that restores confidence and liquidity to the credit markets, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the Federal Treasury for short-term financing," Schwarzenegger wrote.

A spokesman for the state treasurer's office said pursuing a federal loan is just one option if the credit markets do not respond as Paulson predicted. California also will seek private loans within the next few weeks, spokesman Tom Dresslar said.

Unless it can secure those loans, the state is expected to run out of cash Oct. 29.

Earlier this week, the controller's office said California will need to borrow $7 billion to pay its expenses throughout the fiscal year, which ends June 30.

"We hope that (the bailout plan) will be sufficient to loosen the tight credit market so that the treasurer can issue the $7 billion we need," said Hallye Jordan, a spokeswoman for the state controller.

John McCain and the future of the Republicans

Most attention in the U.S. Presidential elections has been given to the Democratic Party, and the wide schism revealed in its support base between supporters of Hillary Clinton (majority of women, Latinos, older voters, lower income, lower average levels of education) and Barack Obama (majority of African-Americans, younger voters, higher income, tertiary educated). It has been cast as “a standoff between the Dukes of Hazzard and the Huxtables” , but its fault lines are pretty clear. This cannot be said for the Republican Party going into the 2008 elections.

John McCain does not bring a strong hand to the election, although the ongoing saga of the Democrat nominee has helped somewhat. There is usually a change in the governing party after eight years of one President holding office. While this was not true in 1988, George Bush gained the presidency with Ronald Reagan having a personal approval rating of about 60%. George W. Bush has a personal approval rating below 30%, and sinking. Even if his approval figures were better, this would be no guarantee against change. Bill Clinton left office with personal approval ratings over 60%, but his Vice-President Al Gore could not defeat the Republicans in 2000.

The position of the Republicans as a party is far worse than that of John McCain as its presumptive Presidential nominee. Having lost control of both the Senate and the House in the 2006 mid-term primaries, they have recently experienced three major losses in special Congressional elections. The most recent loss was in a presumed safe seat in Mississippi, where there was a 20% swing to the Democrats. Several Republican analysts have warned that the Republican ‘brand’ is ‘dog food’, and if it were a product it would be taken off the shelf.

Reasons for this are many and varied, and go well beyond commitment to the War in Iraq. Basically, the Republicans in Congress have been sinking with the Bush presidency, and the sense of malaise and policy failure that surrounds it. The question is where John McCain goes in relation to it.

McCain has some distance from Bush, and has accentuated it in recent times with a speech in New Orleans condemning how Hurricane Katrina was handled in 2005, and a recent speech (sort of) acknowledging the threat of global warming. The question, however, is not simply one of personal style and belief, but goes to the heart of where America’s conservative party wants to be over the next decade.

The question revolves around two axes. One is economic. Conservatives view the fiscal profligacy of the Bush years with horror, as it has combined large and regressive tax cuts (which they would otherwise support) with a big increase in government spending, not just on the war in Iraq, but also on a wide range of social programs. They see that as reversing the ‘Reagan doctrine’ and recreating a culture that all social problems are addressed through more government spending, throwing fiscal conservatism out the window, ad denying them any real point of differentiation from the Democrats. Moreover, the groaning fiscal and trade deficits adversely impact on foreign policy. The recent tax cuts to avert economic recession were described a “Borrowing more money from the Chinese to pay for oil bought from the Saudis.”

The other axis is cultural, or what are also termed ‘faith and values’ issues. McCain has recognized the problems that arise from the Republicans being tied to the evangelical Christian right, particularly with younger voters – he has made thirteen appearances on The Daily Show with Jon Stewart, which conservative pundits such as Bill O’Reilly would dismiss as a show for “stoned slackers”.

A move to the cultural centre would be to follow what might be termed the ‘Arnie strategy’. As Governor of California, the largest state in the U.S. in both population and economic terms, Arnold Schwarzenegger is one of the nation’s most politically successful Republicans. Schwarzenegger e governs what is otherwise now a Democrat state – even though it is the home state of Richard Nixon and Ronald Reagan – by recognizing that the social liberalism of the state and aligning this with economic conservatism and pro-business policies.

The centrist ‘Arnie strategy’ appeals to McCain, and makes a lot of sense in an election where the Republicans now have a real opportunity in capturing the vote of Hillary Clinton supporters if Barack Obama is the Democrat nominee and they can position Obama as ‘too liberal’. The catch is that the support base of the Republicans – from Christian lobby groups to influential donors to the bevy of conservative columnists, radio talk show hosts and TV pundits – have run so long and hard on a conservative ‘culture wars’ position that they will feel let down by a Republican nominee who does not align to these values and positions on their favoured ‘hot button’ issues.

The silence of all sides (McCain, Obama, Clinton) on the California Supreme Court decision to overturn the ban on same-sex marriages indicates how tricky these issues are becoming. They are much more complex for the Republicans than the Democrats, since making a big issue of such decisions in order to mobilise the conservative base has been the sine qua non of Republican politics for decades.

McCain’s dilemma, and how he addresses it, will influence the shape of conservative politics worldwide for some time to come, just as the ‘Reagan revolution’ has been a defining influence globally for the last 30 years.


PS: To get a sense of how hard it may be to retrain Republican supporters from well-established habits, see conservative talk-show host Kevin James’s responses to MSNBC’s Chris Matthews on whether talking to political enemies is the same as appeasement, which apparently ‘energized’ Hitler in 1939.