Is California Too Big

to be allowed to fail? The state of California has asked the federal government for a bailout of $7 billion:

LOS ANGELES — With the credit crisis cutting off access to short-term financing, California has asked the United States government to lend it $7 billion, warning that the state could run out of money in a few weeks without it.

Gov. Arnold Schwarzenegger in a letter Thursday night to Treasury Secretary Henry M. Paulson Jr. said that with credit markets essentially frozen, the state, like a slew of others and local governments nationwide, had no access to short-term financing that normally support day-to-day operations.

“California and other states may be unable to obtain the necessary level of financing to maintain government operations,” Mr. Schwarzenegger said in the letter, which was first reported by The Los Angeles Times.

In reaction to the LA Times coverage of this story this morning James Joyner observed:

Lending money to the states would seem like a no-brainer, regardless of one’s views of bailing out/rescuing the big banks.

I’m not certain that’s completely true.

There are several issues here. The credit crunch has placed many state and local governments, like many businesses, in a fix. They’ve become accustomed to managing their cash flow by taking out short-term loans. This has enabled them to function with a lower level of capitalization in the form of cash on hand than they’d otherwise need. When these interest rates are low and credit is readily available that makes sense. It’s a better use of money, a more efficient way to operate.

But the higher costs that higher short-term interest rates impose may prove disastrous for some companies, even some governments. They either need to improve their cash flow, learn to endure the tighter or more expensive credit, or go under.

California has been in a condition of tax revolt for decades, ever since Proposition 13 passed. Rising property values have provided incentives for Californians to buy and sell houses rather than buying and holding them which, ironically, defeats the very reasons that home ownership is encouraged, e.g. neighborhood stability. But that has shielded California lawmakers from the implications that the tax-freezing provisions of Prop 13 provides. Rather than being protected from confronting voters with hard political choices rising property values have enabled politicians to kick the can down the road.

Now Californians don’t want to pay higher state income taxes, don’t want to pay higher property taxes, don’t want to deal with fewer government services, and keep electing the politicians who vote in favor of fiscal irresponsibility back into office.

The state now has a problem that goes well beyond one that can be solved with short-term credit: its expenditures are growing on a sharply higher trajectory than its revenues and neither credit nor tax reform alone will solve the problem. California needs to reduce state payrolls. There really is no other alternative and extending credit to the state just kicks the can farther down the road. It’s not in the position of a bank with a few toxic assets dragging its balance sheet down. Its insolvency is deeper than that.

If credit is issued to the state of California by the federal government, it should carry substantial requirements for fiscal reform in the state along with it. California’s legislators simply won’t muster the political will to take the necessary, painful steps that California needs otherwise.

2 comments… add one
  • Hi Dave,
    I live in California, and I wouldn’t lend the state a dime without mandating severe cuts in spending, among other things. The state has been livin g on borowed money and accounting tricks for a long time that woul dput you or I behind bars and is effectively bankrupt because of (a) the effect of massive illegal immigration on state services, abetted by state and local politicians (b) the inability of the Democrats who run the state legislature and the local municipal and county governments in the most populous parts of the state to exercise even the remotest glimmer of fiscal responsibility and (c) high taxes and regulations that have driven many businesses out of the state, which has exacerbated the existing real estate debacle.

    For anyone wondering what an Obama presidency would be like, California is a superb predictor.

    All Best,
    ff

  • PD Shaw Link

    Or California could do it the Illinois way, and take federal money earmarked for special purposes and transfer it into the state’s general funds accounts. I hear the feds are started to look for all the neat things they thought they bought. Suckers!

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