California's budget crisis

Meltdown on the ocean

As the state’s finances disintegrate, for many so does the California Dream

ALTHOUGH one would hardly know it from the antics of its politicians—or from its newspapers, which all this week were fixating on Michael Jackson’s funeral rites—California is in as serious a condition as an American state can be. Legally unable to declare bankruptcy as a company would, the state has begun paying many of its bills with IOUs instead of cash. One of the three big credit-rating agencies, Fitch, this week downgraded the state’s bonds, already the lowest-rated such bonds in the country, to BBB, within spitting distance of “junk”. Government offices are closed on some days, as state workers take involuntary and unpaid furloughs. Taxpayers are still waiting for refunds. Poor people are afraid of losing their state-funded health insurance. Parents, fearing ever shabbier public schools, have another reason to think about moving out of state.

Meanwhile, the governor, Arnold Schwarzenegger, and the leaders of the legislature have been frantically scoring points off each other in Sacramento, the state capital. As the previous fiscal year drew to a close on June 30th, Darrell Steinberg, the Democratic leader of the Senate, and Karen Bass, the Democratic leader of the Assembly, were proposing some stopgap measures that would have saved a dollop in the new fiscal year and averted the issuing of IOUs. But the Republican governor, claiming to insist on all or nothing, said no. Overnight, the budget gap swelled to a staggering $26.3 billion and now grows by an estimated $25m each day.

Mr Schwarzenegger, affecting insouciance as he smoked his trademark stogies, got his team to prepare a mocking YouTube video with footage of a committee hearing about whether cutting cow tails for udder hygiene was inhumane. “Right now, in the midst of a budget crisis, they are debating about cow tails, and I think that this is inexcusable,” Mr Schwarzenegger sneered, even as he chucked new reform proposals into the negotiations that are entirely unrelated to the current budget crisis.

Exasperated, Ms Bass, who had already backed off from any idea of raising taxes, muttered something about the lame-duck governor worrying more about “fixing his legacy” than the budget. On July 6th, she boycotted a meeting, demanding that Mr Schwarzenegger restrict the talks to just the budget crisis. As The Economist went to press, there was still no deal in sight.

California thus seems to be doing its level best to come to ruin and, as the nation’s largest economy, to drag the country’s hopes for a recovery down with it. The recession was the trigger but not the cause of the current malaise, which stems, as Fitch put it when explaining its downgrade, from “the state’s continued inability” to balance its budgets.

But what exactly does a crisis look like for an American state? “Falling off a cliff” is the usual metaphor but not an appropriate one, according to Ross DeVol, chief economist at the Milken Institute, a think-tank in Santa Monica. Instead of death on impact, he says, it is a matter of “who suffers in what order and how much?”

With luck the IOUs, officially called “registered warrants”, will turn out to be more symbolic than apocalyptic, provided that banks accept them and that a budget deal arrives soon. The last time California paid with IOUs, in 1992, Bank of America was dominant in the state and kept order. This time many banks must play along, and several suggested this week that they would accept the IOUs only until July 10th. If that practice becomes widespread, bearers may have to wait until October to get their money. For some suppliers this may mean bankruptcy; for students, uncertainty over their college tuition; for consumers without tax refunds, austerity.

And if all this leads to more downgrades, California’s borrowing costs will increase and the budget gap will further widen. But this does not automatically threaten the owners of California’s “muni” bonds, since the state constitution dictates that schools be paid first, bondholders second and then everybody else.

It does, however, increase the pressure to balance the budget. New taxes are no longer being discussed, because California requires a two-thirds majority in both houses of the legislature to pass them, and the Republican minorities are large enough, and partisan enough, to block them altogether. This means that the budget must be balanced by cuts alone.

The largest part of the budget, and thus the biggest target for cuts, is education. Mr Schwarzenegger has proposed suspending a spending formula that voters explicitly chose at the ballot box. In response, the powerful teachers’ union sent a gesture, in the form of 10,000 protesting postcards, to one of Mr Schwarzenegger’s branch offices. But teachers and schools will suffer, which hurts children and thus parents.

The next largest part of the budget is the state’s social safety net, including its health-care programme for the poor. Mr Schwarzenegger wanted to eliminate entire programmes wholesale, but now appears ready to settle for shrinking them. The debate, such as it is, is now about how many children will lose coverage, how many elderly Alzheimer’s patients will stop receiving visits from nurses, whether to treat drug addicts and so forth.

The pain thus seems likely to flow to the bottom of the social hierarchy. But all Californians will notice. Their parks may close, their neighbourhoods may become less safe. “The Californian Dream is at least temporarily suspended,” says Mr DeVol.