The Thing Is, We Cannot Default As A Matter Of Law

I've seen a bit of confusion in traditional media accounts of California's budget situation, and whether or not the state should receive a federal bailout. This seems to go toward the idea that without federal aid, California will default on its creditors and go bankrupt, and the federal government has a compelling interest in keeping that from happening. You can argue whether or not it would actually make sense for the state to default - it certainly worked pretty well for Argentina, despite neoliberal fuming to the contrary. And as noted by Peter Schrag in the above-linked entry, the Governor has never asked for any help of this kind, and given his status as a born-again Friedmanite, would probably reject it. But Paul Kedrosky, who has read the relevant law, explains in a piece supporting default that California really cannot do so.

The root issue, of course, is that California is insolvent, and irritating people like S&P analysts keep noticing. The state -- let's call it Latvia by the Pacific -- has a $24-billion budget gap that must be closed for it to continue operating (and I use that word advisedly). Without a clear sense of how that will happen rational creditors are going to be increasingly skittish about filling the hole. Now, does that mean California can't sell enough bonds to backfill the gap this time? You bet it can, and it will. This is part Schwarzenegger/Lockyer Financial Theater, and partly a laughably transparent attempt to demonstrate budgetary semi-competency in hopes of a few basis-points of relief on the inevitable bond sale. That's all.

Because California has $5.7-billion in debt servicing obligations. And while that will grow, debt occupies pride of place in California's constitution -- only education must be paid off before the next slug of cash goes to creditors. Get that? Healthcare, prisons, and other frivolities can all go to rack and ruin, but creditors must be paid, constitutionally speaking. That means, if you're looking at this through the gimlet eyes of muni-bond ghouls, that California has something like $50-billion in budgetary space to make its $5.7-billion in payments. It's pretty easy to calculate that California can make the payment nut, even if it has to close hospitals, release prisoners and stop patrolling the highways to do it.

Now, Kedrosky thinks this is theatrical and should not be rewarded. I say it's the perfect reason for California, and actually all states with this kind of constitutional arrangement, to receive those federal loan guarantees to stop gouging from Wall Street for short-term bonds. Not only do Schwarzenegger and Lockyer know we have to pay back all out debt, so do the bondholders and the rating agencies. It's almost literally impossible for us to default on those bonds, short of the entire state's residents spontaneously getting fired at once. If those loans will obviously get paid back, the interest shouldn't be set at payday-loan rates. And the federal government could very easily remedy that situation, at no cost and probably at a profit, as they reaped from the loans to New York City in the 1970s.

Is it a problem that California operates at the mercy of its creditors? In a sense. Is there a remedy? At the least, there's a way to get some equitability into the process so that we aren't blowing money on Wall Street firms who have been bailed out by those same Feds ten times over. In addition, this kind of thing weakens the municipal bond market, and the federal government has an interest in keeping credit flowing through that.