CAL MAY BE UNBROKEN, BUT SO IS A WILD HORSE

By Wayne Lusvardi

In an opinion piece in the Los Angeles Times, State Treasurer Bill Lockyer got on his high horse to state “California isn’t broken,” won’t default on its debt payments, and isn’t anti-business. http://articles.latimes.com/2010/dec/20/opinion/la-oe-lockyer-california-outlook-20101220

Lockyer obviously is trying to issue some reassurance to bond markets.  The bond market recently demanded almost a half percent risk premium to sell California’s general obligation bonds and could only sell about 60% of the bonds put on the market compared to 75% last year in November.  There were no buyers for the other one third of the bonds even with the rate kicker added. 
http://www.debtdebtrelief.com/california-bond-issuance-fail/.  Rumors in the bond markets were that the Federal Reserve was going to snap up the un-bought bounds. http://shtf411.com/california-bond-sales-hit-cold-cold-world-t10829.You can lead a horse to water but you can’t make him drink. Investors are gradually losing confidence in California’s bond issues. 

Lockyer’s attempt to reassure the bond market that California isn’t broken is understandable, albeit not totally honest. California may presently be unbroken, but a wild horse is unbroken too.

Bond markets don’t operate solely on a balanced state budget, credit rating, or debt ratio but on anticipation and confidence that the bond interest will be paid over a 20-year term.  Financial wealth partly consists of promises and confidence in those promises.  Money and credit are not only material resources but also social perceptions that can only be generated if we believe in government’s legitimate right to rule.  Legitimacy, not merely a balanced budget, is necessary to sustain credit and money transactions.  We must believe others will honor their promises to pay their debts, whether they are former renters turned into homeowners to meet affordable housing goals, a solar power developer needing massive subsidies, or a state government issuing I.O.U.’s. 

Put in terms social progressives might understand, financial legitimacy is not gauged by reassurance or love. http://www.bloomberg.com/news/2010-12-21/bond-market-rejects-fed-s-unconditional-love-commentary-by-caroline-baum.html. To financial markets, votes or media spin don’t translate into investor confidence.  And damaged confidence can’t be repaired by huge bailouts or massive green jobs programs.  That would be like shutting the barn door after the horse has bolted. 

For example, we heard some of the same type of reassurances from the Federal Reserve just before the financial meltdown of 2008, but Wall Street ignored the attempts at reassurance.
http://www.guardian.co.uk/business/2008/mar/19/useconomy.creditcrunch

According to a new book “Senseless Panic: How Washington Failed America” by former head of the FDIC William M. Isaac (with a foreward by Paul Volcker), the financial liabilities of subprime loans weren’t particularly large or crippling and were manageable. http://www.amazon.com/Senseless-Panic-Washington-Failed-America/dp/0470640367   

William Isaac makes the case that financial institutions lost confidence when“government’s actions were ad hoc and inconsistent, … no one appeared to be in charge with an overall plan, statements were made that proved to be false, the public was provided inadequate information, and decision making seemed dominated too much by political considerations.”

What apparently also panicked the financial markets was the prospect that the U.S. is broke when looking at future health and welfare obligations, not just current balance sheets. http://www.moneynews.com/StreetTalk/Kotlikoff-US-Broke/2010/08/12/id/367357. The national meltdown of 2008 may have been a loss of confidence reflected by a revolt of the financial markets against government and against some of their own reckless financial institutions that reaped windfalls on unsustainable social lending policies.  The national financial meltdown was a panic not a crash.

Coming back to the California situation, even liberal academic institutions are wary of state and local government meeting their huge future pension obligations in California.  A crisis is projected to unfold as early as 2014 to 2020 - http://www.calwatchdog.com/2010/11/02/expect-more-population-flight/.  Financial institutions see no viable plan in place yet to meet these huge pension obligations that would overwhelm the operating budgets of many cities and counties rendering them unable to deliver even basic first-responder services. In his newspaper article Lockyer did not elaborate on how California, or its many municipal governments and schools districts that are a part of the Cal-PERS and Cal-STRS pension systems, are going to pay for such huge pension obligations.  If wishes were horses, beggars would ride.

Lockyer’s assertion that California would not default on its general obligation bonds sounds like a half-truth.  Gov.-elect Jerry Brown and Lockyer have already informed the public that the state budget deficit is going to be crammed down to local governments and school districts.  So it is counties, cities and school districts that are more likely to default if the state budget deficit is passed-through to them. 

Even if another planned round of budget cuts to schools does not cut into core education funding, school districts have a tendency to cry that the “sky is falling,” which might further erode confidence in local bond issues. Every horse thinks its own pack is heaviest.

But there are other factors eroding confidence in California debt. 

State officials may say California is not anti-business but the reality and the perception may be different.  California is at the bottom when it comes to comparing it with other states as to overall tax burden:
 

California Tax Rank (1st least taxed; 50th highest taxed)

Property Tax	Sales Tax	Corporate Income Tax	Capital Gains Tax on Real Estate	Gasoline Tax	Utility User’s Tax	School Parcel Tax	Overall Rank by author
18th	49th	33rd	50th	50th	50th	50th	50th

Source: Tax Foundation and author

http://www.calwatchdog.com/2010/11/12/business-property-not-under-taxed/

And Gov.-elect Jerry Brown’s announcement that he is going to require voters to decide whether they want “essential public services or higher taxes” is a false choice that leaves many subsidies for luxury public goods and services intact while the state safety net funds are broke.  The untouchability of luxury environmental programs and stem cell research will only further erode the legitimacy of the state to push for tax increases -http://www.calwatchdog.com/2010/12/14/ca-budget-filled-with-luxury-items/

California is hell bent on rolling out expensive green power and cap and trade programs in the middle of a recession just as natural gas prices are falling.http://www.calwatchdog.com/2010/11/24/green-bust-coming-to-brown-ca.  As predicted, T. Boone Pickens just announced he is pulling out of investing in wind energy citing the low price of natural gas as rendering green power uncompetitive in the energy markets.http://online.wsj.com/article/SB10001424052748704368004576027310664695834.html?mod=WSJ_Opinion_LEFTTopOpinion 
The unemployed and politicians are desperate for jobs, but at what cost to electricity ratepayers and at what social cost to confidence in financial markets?

Even the Democrat-controlled Federal Energy Regulatory Commission (FERC) in July, 2010, denied California Attorney General Jerry Brown’s petition to load the extra cost of green power onto the backs of electricity ratepayers through “feed-in tariffs.” http://www.calwatchdog.com/2010/11/08/feds-to-erode-cas-green-power-edge/.  So issuing any revenue bonds for green energy projects has already been precluded. 

Of possible greater concern is the unpredictability of California with its reckless environmental regulation and lawsuits that are not subject to control by the governor or the legislature.  

· The past two years California suffered a “wet drought” caused by an environmental lawsuit to protect a small fish in the Sacramento Delta based on bogus science.  This resulted in a high rate of unemployment in California’s Central Valley agricultural economy.

·  The Water Quality Control Board has mandated that 19 coastal power plants convert from ocean-water cooling systems to costly chillers (refrigerators) to save 57 sea lions per year while 1,000 people per year die on Coast Highway 101.  The real agenda of this mandate appears to be to raise the cost of conventional energy so that green power can compete in energy markets.

·  It has now been revealed that the infamous contamination from chromium 6 in Hinckley, California near Barstow (of Erin Brockovich fame) has resulted in no more cancers than normal - http://articles.latimes.com/2010/dec/13/local/la-me-hinkley-cancer-20101213

Lockyers’s claims that California is not broken, won’t default on its debt, and isn’t anti-business isn’t born out by the realities at hand:

· California’s Unemployment, Worker’s Compensation, CalWORKS, and Medi-Cal funds are broke.  These funds have been patched by Federal loans and subsidies for the last two years but the availability of these funds is running out. Gov.-elect Brown and state Treasurer Lockyer have not detailed how they plan to fund these broken safety net programs.

·  It isn’t fully honest to say that California won’t default on its bonded indebtedness when it has made clear that it is cramming down its budget deficit to local governments and school districts who may be more prone to default. The risk of default on state bonds is a horse of a different color than local government defaults.

·  California’s near-worst or worst ranking as far as overall tax burden is not “business friendly.” Neither are reckless environmental regulation and lawsuits that can eat up revenue like a horse.  

To repeat the forboding words of former FDIC Chairman William Isaac cited above, neither Gov.-elect Jerry Brown’s or state Treasurer Bill Lockyer’s recent pronouncements indicate that California’s leaders have an overall plan other than to raise taxes and utility rates; many of Lockyer’s statements are half-false; the public is not being provided with adequate information as to the greater risk of local government defaults; and the timing and decisions of public officials seem overly dominated by political considerations.

California officials can issue reassurances and temporarily plug budget deficits with Federal bailouts or hyped green jobs programs. But none of this is likely to have any positive bearing on investor confidence, as shown by the results of the Federal Stimulus Program thus far.  The source of California’s financial distress is social, not solely material.  

California may be unbroken, but so is a wild horse.