California Finally Runs Out of Cash

This post first appeared on Minyanville.

It's official: California is broke.

For months, the most populous US state has been in the throes of a historic budget crisis, as lawmakers have repeatedly failed to agree on how to resolve a $24 billion deficit.

What was once the country's richest state is preparing to issue IOUs to a host of creditors, according to the Financial Times. Among the dubious recipients of these IOUs: Contractors, information-technology companies, and food-service groups that cater to prisons. Funding for education and interest payments on its bonds are guaranteed by state law.

Governor Arnold Schwarzenegger is taking a hard line with legislators, accusing them of offering up a piecemeal solution to the state's woes: "I will veto any majority tax increase bill that punishes taxpayers for Sacramento's failure to live within its means. It's time for the legislature to send me a budget that solves our entire deficit without raising taxes," the Governator said yesterday.

Lawmakers appear blindsided. It's almost like the state went broke all of a sudden and they haven't had time to properly prepare a solution. Not true: The state has been in and out of financial crisis for more than a decade.

After Schwarzenegger vetoed an $18 billion budget package in January, calling it "deeply flayed [sic]," members of the California legislature pulled a literal all-nighter to try and agree on spending cuts, tax hikes, and other measures to get the state back on sound financial footing. The proposed agreement -- hailed as an eleventh-hour solution to what could have become a fiscal nightmare -- was put to a state-wide referendum in May.

Voters rejected the proposal, soundly. Of the 5 measures on the ballot, the only one that passed were new rules that cut the pay for elected officials. And for good reason.

California politicians are a woeful bunch. Despite being home to some of the most profitable and innovative companies in the world, the state is perennially short of cash. Oracle (ORCL), Google (GOOG), and Genentech (DNA) all hail from the San Francisco Bay Area, while San Diego remains a mecca for biotechnology research and is home to mobile-communications giant Qualcomm (QCOM).

The state has vast natural-resource reserves, has a booming agricultural industry, is a popular tourist destination, and has some of the most heavily trafficked ports in the world. Good weather and generally high quality of life has made California the destination for dream-seekers for more than 150 years.

Yet, despite everything it has going for it, California's political process is a complete disaster. In an attempt to allow voters to play a more direct role in governance, the state's referendum system allows citizens to collect signatures and get measures onto statewide ballots. Enough votes on election day and any Californian can see his or her whimsical dream become law.

This has created a patchwork of legislation, rules, and special interests that have hogtied what would be the seventh-largest economy, were it to be a sovereign nation.

As the calendar turns tonight on its new fiscal year, California could be the first state -- like its bailout-begging brethren on Wall Street -- to go hat in hand to Washington pleading for a rescue.

GM: One Step Closer to Nationalization

This post first appeared on Minyanville.


The great modern American nationalization experiment is underway: General Motors (GM), once the largest automaker in the world, has become a sort of Frankenstein's monster for the US government.

Bloomberg reports the Obama Administration is stepping up pressure on management, unions and creditors to make further concessions, and is considering taking a sizable equity position in the once-proud Detroit firm. The move, which would swap out some of the outstanding $13.4 billion in government loans for stock in a new, slimmed-down, cleaned-up version of GM, is the latest in a series of steps toward outright nationalization.

Analysts say the swap would diminish the rights of creditors, to whom the company offered around 90% ownership in a recent restructuring plan - a plan rejected by government officials. Under the Obama Administration's preferred tact of temporary state ownership, employees owed pension benefits would end up faring better than bondholders.

The government aims to take an ownership interest in GM, then quickly use the cover of bankruptcy courts to hack off the 'bad' parts of the firm. With a fresh start, free of legacy obligations and under performing divisions, Washington says it would quickly divest of it's stake and let the restructuring process continue.

We've by now become almost numb to government-led bailouts of failed companies, most notably American International Group (AIG), Fannie Mae (FNM) and Freddie Mac (FRE). The details are almost an afterthought, as the complexity of each scenario renders casual analysis almost a waste of time. The GM situation, however, could be a blueprint for future intrusion of the federal government into private enterprise.

Secured lenders, as is the government in the case of GM, often prefer a bankruptcy filing when companies get into trouble since it can enable the quickest repayment of their loans in full. Unsecured creditors and equity owners are left holding the bag.

The Bush Administration before him and now Obama have set a precedent: Emergency, secured loans are a likely precursor to state ownership. Notably, the huge bailouts of Citigroup (C) and Bank of America (BAC) were executed through portfolio guarantees and capital injections, not secured loans to the company itself. Not yet, anyway.

Despite efforts on the part of officials to play down the government's role in running GM, or AIG, or Citigroup, or Bank of America, we have entered an economic reality where business success, rather than relying on vision, strategy and good practices, is becoming increasingly reliant on political acumen.

By adding layers of red tape and palm-greasing to our already politicized economy, we move closer and closer to an economic system directed not by the collective will of the many, but rather one controlled by an ever-shrinking group of power brokers and political puppeteers.

This, despite loud proclamations of an impending return to economic vibrancy, is not a welcome development.