"Free Lunch" Era Is Over

Florida and California continue to make the news. Just yesterday in More Budget Cuts in California, New Jersey, and Florida I noted the following.

• California's budget deficit grew from $14.5 billion to $16 billion in the last two months.
• New Jersey is facing a budget freeze
• Florida is threatening to layoff circuit court employees for 11 of the next 19 weeks without pay
• Akron, Ohio wants to sell its sewer system to give "free" tuition to city residents

Inquiring minds may also wish to consider Vallejo California On Brink Of Bankruptcy.

Clearly the Matter Of Choice keeps growing larger and larger. California already has to make 10% budget cuts and I can't help wondering when that will become 20%.

Here Are The Choices

• Raise Taxes
• Fire workers
• Reduce Pay

The Era of the Free Lunch is Over.

Muni Auctions Continue To Fail

Today California and Florida are back in the news in relation to municipal bonds. Bloomberg is reporting Florida Schools, California Convert Auction-Rate Debt.

California, Florida schools and the owner of John F. Kennedy International Airport joined a growing list of municipal borrowers exiting the U.S. auction-rate bond market as record failures push taxpayer costs higher.

Rates in the more than $300 billion auction market, where local governments, hospitals, museums, student-loan agencies and closed-end mutual funds borrow, are determined through a bidding process every seven, 28 or 35 days. Auctions fail when there aren't enough buyers. That's left bondholders who wanted to sell stuck with the securities and taxpayers or other backers of the debt such as fund holders with higher interest costs.

Yesterday's 641 auctions of publicly offered bonds resulted in 395 failures, or 62 percent, according to data compiled by Bloomberg from four auction agents.

Failed Auctions Mean Higher Rates

Failed auctions mean higher costs for already cash strapped municipalities. Budget deficits will rise because of this. In addition, some muni holders, especially in closed end funds are finding themselves trapped in a market with no bidders.

Professor Sedacca summed up the Auction Rate Security (ARS) situation nicely with his piece Pain In The ARS. I took the liberty of expounding on his idea and added a bit of history in Too Late To Protect Your ARS.

The Great California Exodus

How many times did we here that boomers wanted to retire to California? Probably too many to count. It's now demographics in reverse as the California exodus turns to stampede.

California, which once lured Americans from near and far, is now driving out millions of the most productive residents – including high percentages of the most affluent.

"When California faced a Mount Everest-sized $14 billion deficit in 2003, one of the major causes for the red ink was the stampede of millionaire households from the state," says a report called "Rich States, Poor States" by economists Arthur Laffer and Stephen Moore."

[Click on that link to see how your state stands]

The bad news for California is that it faces a $14 [$16 billion and growing] deficit this year, despite boasting one of the highest tax burdens in the nation.

Let's Review The Choices Again

• Raise Taxes
• Fire workers
• Reduce Pay

Is raising taxes going to help? I think not, it will cause more of the affluent to leave, further shrinking the tax base! California has no realistic choice other than to fire workers or reduce pay and benefits of government employees.

Email From Carol

A friend of mine named Carol wrote to me this morning:

We have considered moving down to CA for several years (my husband and I both grew up there), but one of the big sticking points is the higher tax load. Where we live now, in Washington State, there is no personal income tax. So a move down to CA for us would be a double-edged sword financially: higher living costs and lower income (from higher taxes).

All that for a little more sun and several tens of millions more people. We haven’t made the move to CA yet, and we may never make it.

Free Lunch Era Is Over

Failing muni auctions in conjunction with the likely bankruptcies or defaults by Ambac (ABK) and MBIA (MBI) mean the days of perpetually floating more bonds to meet current expenses has dried up.

It had to end sometime and so it did. The end of the free lunch is over for California (and many other states too). Real choices now have to be made. Furthermore, the sinking dollar at some point will put an end to the Free Lunch Era at the national level too.

Those addicted to the "free lunch" are headed for a forced withdrawal. While misguided talk of a second half recovery is emanating from Bernanke, Bush, and Paulson, budget cutbacks and a commercial real estate implosion are going to ensure this recession is both long and deep. Sadly, hardly anyone is prepared for it.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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