In the continuing downward spiral that is California’s financial condition, Bank of America, Wells Fargo, Citigroup, and JPMorgan Chase (collectively, the Third Bank of the United States) have now changed tack and stated that they will not accept the state’s 3.75% IOUs after all:
A group of the biggest U.S. banks said they would stop accepting California’s IOUs on Friday, adding pressure on the state to close its $26.3 billion annual budget gap.
One has to wonder how closely this is related by yesterday’s Fitch downgrade of California’s debt to BBB with a negative outlook.
The inability of the state to reach agreement has prompted the controller to begin issuing IOUs for non-priority payments, primarily disbursements to vendors, for certain social services, and for tax refunds, in order to ensure payment of priority payments, including GO and lease debt service. The controller’s office estimates that $3 billion in IOUs will be issued during July 2009; priority payments of $10.8 billion will be made for education, debt service, Medicaid, payroll, pensions and other mandatory contractual obligations. Projections will be revised to reflect June revenue performance and other changes but as currently estimated, cumulative cash deficits of $3.7 billion are projected through August, offset by $4.5 billion in non-priority payments that could be covered with IOUS, excluding tax refunds. However, by the end of October, the projected cash deficit expands to $16.1 billion, well beyond non-priority spending of only $10.6 billion, excluding tax refunds.
This is madness. That it is slow-moving does not make it any less mad.
There is no statute in place for state bankruptcy; the notion that states are sovereign entities, largely put to rest in early April 1865, lives on in government finance. But we all know it is a fiction. California may have the notional right to abrogate its debts or unilaterally amend its contracts, but as anything approaching a practical matter it is impossible. The Federal government isn’t going to let $26bn stand in the way of a constitutional crisis, or for that matter a serious appraisal of what it means to allow states to incur debts severally without a provision for enforcing claims.
Indeed, it is hard to avoid the feeling that everyone in Sacramento is filibustering the decision, hoping that if they refuse to make any choice long enough, the problem will be so large and intractable the Federal government will feel bound to step in and discharge all their debts. Hell, it worked for AIG.
When the former Confederate States of America applied for admission to the US (at point of sword), they were required to accept the 13th-15th Amendments to the US Constitution and to adopt state constitutions that met with Washington’s approval. Perhaps it is now time to revive the concept that Federal intervention comes at a price; if nothing else, the price being adequate restructuring to give some confidence the problem will not re-appear (Timmy, we’ll talk later about this concept).
Right now the Feds are trying to stay away from CA’s crisis to keep from owning it, and that is a reasonable approach. However, sooner or later the gap will refuse to be ignored – and it looks to be sooner. At that point, I would hope the government would say:
Sure, we’ll close the deficit for you. The cost of the money is as follows:
- Proposition 13 is eliminated, and property tax rates are reset to no less than the average of the other 49 states;
- Proposition 98 is eliminated;
- An oil severance tax of 25% above extraction cost is imposed, same as Alaska;
- All public employee pension funds need to be fully funded at all times;
- The state must operate a balanced budget as determined by the GAO;
- All supermajority governing provisions are eliminated.
The state would not like it, but sooner or later it would reconcile to the situation and get on with its affairs. It is a fantastic piece of property occupied by creative, industrious people; it should do far better than it has.
UPDATE
It appears Californians can use the IOUs as payment for tax bills.
Taxpayers must sign the back of their IOUs and write, “Pay to the order of the Franchise Tax Board.” The promissory note can then be mailed in with the tax bill, the board said.
Congratulations, California, for creating your own crappy currency. Recall elections, street protests…it’s not easy to go from the First World to the Third World.
