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Sunday, December 16, 2007 9:36 PM

Turn out the lights California, the party is over

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Years of reckless spending have finally caught up to the State of California, forcing Schwarzenegger To 'Declare Fiscal Emergency'.

Gov. Arnold Schwarzenegger said Friday he will declare a "fiscal emergency" in January to give him and the Legislature more power to deal with the state's growing deficit.

The shortfall is not $10 billion, but more than $14 billion -- a 40 percent jump that would put it in orbit with some of the state's worst fiscal crisis, those who have met with him said.

A fiscal emergency would trigger a special session and force lawmakers and the governor to begin addressing the shortfall within 45 days.

"What we have to do is fix the budget system. The system itself needs to be fixed, and I think that this is a good year, this coming year, to fix it," Schwarzenegger said in Long Beach, where he was promoting his plan for health care reform.

California is struggling with shrinking state tax revenue from the meltdown of the subprime housing market and the credit crunch on Wall Street.

State spending also has increased by more than 40 percent since Schwarzenegger took office after the 2003 recall of then-Gov. Gray Davis.

Schwarzenegger in August signed a $145.5 billion budget that increased spending 11 percent due largely to the increased cost of bond repayments and special funds. General fund spending for day-to-day operations increased less than 1 percent, from $101.7 to $102.3 billion for the budget year that began July 1.

In August, Schwarzenegger's office projected the state would end its current budget year with a $4.1 billion reserve. Last month, the state's nonpartisan legislative analyst reported that the state would instead end the year in the red, and was on pace to rack up a staggering $10 billion deficit over the next 18 months.

Schwarzenegger and his top aides this week have privately told lawmakers and interest groups that the gap could top $14 billion and warned cities, counties and health and welfare agencies to expect cuts.

Last month, Schwarzenegger ordered agency leaders to draft plans for across-the-board cut as high as 10 percent.
Flashback March 2, 2007
Schwarzenegger wants $500 billion to rebuild California.

Sound Bytes
  • $42.7 billion in general obligation bonds issued last year is "only the foot in the door, to whet the appetite."
  • It will take $500 billion to "rebuild California the way it ought to be".
  • $500 billion is "too big for people to digest, so you don't talk about that" even though he is talking about it.
  • California needs $500 billion even though it has "done tremendously with the revenue increases".
  • California will not issue less debt even if the economy slows.
  • California "could face lower tax revenues" but he opposes tax hikes.
Well here we are, 9 months later and the $4.1 billion reserve went to a $14 billion deficit in the last 4 months.

Schwarzenegger says he wants to fix the system. I agree. However, what needs to be fixed first is Schwarzenegger. State spending has gone up a whopping 40% in four years and earlier this year he wanted $500 billion to build California the way it ought to be built. Fat chance getting the bond market to go along with anything remotely close to $500 billion now with California's shrinking revenues.

His so-called plan to reform health care is nothing more than a sleight of hand shell game robbing Peter to pay Paul. I talked about that on October 27 in Drop in Revenue Growth at State and Federal Level.
His latest scheme is to use lottery proceeds to expand health care. Given that lottery proceeds now fund education, the governor's proposal would replace money from the lottery that now goes to education with funds from the state's general fund. Schwarzenegger did not say what would be used to fund the shortfall in the state's general fund.
Notice how quickly that $4 billion surplus turned into a huge deficit. That should be enough to tell you that the deficit is way understated. Worse yet, the fiscal crisis in California has barely started. Watch what happens when property values collapse another 25% which they will easily do.

Schwarzenegger has pledged to not cut spending even if the economy slows. He has also pledged not to raise taxes. I bet otherwise.

Schwarzenegger Has 3 Choices
  • Cut Spending and Services
  • Raise Taxes
  • Attempt to float massive amounts of bonds in a hostile debt market
Arnold, it's your move. What's it gonna be?

There is no escape from this box. Note that this year's budget went up 11% and 10% of that was payment on bonds and special funds. Think floating bonds are a good option here? All bond issues would do is postpone the problem. And that problem is going to get bigger, much bigger.

I wrote all of the above yesterday. But the story keeps growing and growing (and it will keep on growing, possibly at an exponential rate).

For some stunning images of the upcoming commercial real estate implosion take a look at an Elk Grove Commercial Real Estate Photolog. I suspect those are typical of what's happening in California. If so, look out below.

Also chiming in on the California story is Dr. Housing Bubble with California Examined: The Deep Budget Impact of the Mortgage Crises.
The current contraction in construction and financial services has hit the golden state particularly hard. Unemployment in the state has increased almost 1 percent since last year going from a low of 4.7% in November of 2006 to our current 5.6% in October of 2007. During this same timeframe, the U.S. unemployment rate has held steady at 4.5% in October of 2006 and is currently running at 4.7%.

California Unemployment

Clearly the impact is being faced disproportionately here in the state because of the heavy reliance on the housing and mortgage industries. This will also have an impact on the state’s bottom line since someone that isn’t working will not be paying any state income tax. They will also hold back from purchasing homes.
M&C takes a look at California in Schwarzenegger prepares California for fiscal emergency measures.
The Los Angeles Times reports the emergency will cause cuts in budgets for schools, colleges, prisons and aid programs for the poor, elderly, and out-of-work that have already spent nearly half their promised funding for the year.

[Mish Note: California's fiscal year starts July 1 so nearly half does not seem so shocking on the surface, but upcoming cuts coming will make it so]

If Schwarzenegger declares a fiscal emergency in January, he's required under Proposition 58, a balanced-budget measure voters approved in 2004, to correct the problem and to call the Legislature into special session to act on his recommendations.

If legislators don't pass a budget bill within 45 days once a special session is called, they would be prohibited from acting on any other legislation or adjourning until they agreed.
Although California is likely the biggest basket case looking forward, this same situation will be played out in many cities and states across the country. Unlike the federal government, state budgets have to be balanced.

Turn out the lights California, the party is over.

Mike "Mish" Shedlock
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