For the State of California and its counties and cities; tax collections tend to be lumpy during the year due to half of all income, corporate and other taxes being collected in the two months of November and April. Given that the fiscal year starts on July 1st and politicians like to spend money all year long; the State and local municipalities have relied on the sale of short term municipal bonds to tax free money market funds to even out cash flow. The total amount of this borrowing can run as high as $25 billion.
Unfortunately for California, with the sovereign debt crisis in Europe and the default crisis in the U.S.; credit rating agencies are in the process of downgrading 7000 muni bond issuers. California who has the lowest rating on the continent, could receive a junk bond rating. Such a rating would make purchase of California bonds by money funds deemed to be imprudent investments. Consequently, California is being forced to try to borrow money from banks at interest costs that may be 5 to 10 times higher in cost.
Starting around the third week in July, California’s Treasury will begin to run increasingly negative cash balances until larger tax payments arrive in early October. With the State continually cash-strapped; those nice people at JP Morgan Bank and their banker buddies bailed California out with bridge loans of $1.5 billion in 2009 and $6.7 billion in 2010 (See here and here.). At the time, because there was no risk of the State being downgraded to junk levels, the interest cost on the two loans were less than 2%. But loaning money to government today is perceived as a much more risky proposition. Last week, JP Morgan bank loaned $2.25 billion to New Jersey, which has a higher rating than California, at a cost of up to 9% interest. At a low 2% cost of interest, it would take 35 years of compounding before the borrowed money would double. But at 9%, the loan doubles in just 8 years.
To instill confidence in the lenders, California voters elected “Moon Beam” Jerry Brown to replace “Terminator” Arnold Schwarzenegger last year. Brown has always been a complicated figure in California politics. In 1975, Jerry Brown became the youngest Governor in the history of the United States by being elected at age of 37. After taking office; Brown was widely liberal on social issue, but was actually a fiscal conservative that favored a Balanced Budget Amendment. After the passage of Proposition 13 limitations on property tax collections, Brown did such a good job balancing the State’s budget that the initiative’s author, Howard Jarvis, actually made a television commercial supporting Brown for his successful reelection bid in 1978.
Two weeks ago, Governor Jerry Brown got a chance to begin to getting back in touch with fiscal conservatism when he was forced to close the purported $9.6 billion State deficit with $5 billion in spending cuts and promises that the sun will soon begin rising in the west. Brown is to be applauded for implementing the first real cuts in the State budget in the last 20 years; but his job was made easier by strong stock market capital gains and very optimistic projections of strong tax growth for the next three years.
California State and local government avoided much of the pain of the 2008 Great Recession that seems like it will never end; but that pain has arrived this year in a big way. It is extremely painful to see large cuts in classroom teachers and active police officers; nonetheless California government employee levels have been cut by 62,000 in the last two years. Unfortunately, according to the UCLA Anderson Business School Forecast, California State and local governments needed to have already eliminated 130,000 positions to balance their budgets.
Over the next three months California Treasurer, Bill Lockyer will need to borrow $15 billion and other local governments will need to borrow $10 billion; just to keep the lights on. A combination of irresponsible spending growth and a very unfriendly business climate has left California looking to the credit rating agencies allot like a dead beat. I am somewhat optimistic that California will find a way to borrow huge amounts of money this year, but the costs of that borrowing will be brutal.
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