California is Too Big To Fail; Therefore, It Will Fail


Back in December I wrote a piece where I stated that California was likely to default on its obligations. Let’s say the state’s leaders were less than pleased. California Treasurer Bill Lockyer’s office asserted that I knew “nothing about California bonds, or the risk the State will default on its payments.” My assessment, they asserted, “is nothing more than irresponsible fear-mongering with no basis in reality, only roots in ignorance. Since it issued its first bond, California has never, not once, defaulted on a bond payment.”

For good measure they labeled as "ludicrous” my comment that the Governor and Legislature may not be able to solve the budget problem next year because “debt service is subject to continuous appropriation. That means we don’t even need a budget to make debt service payments.”

The Department of Finance was also not amused. They resented my prediction that California is on the verge of a default of its bond debt. They insisted that the state has

“multiple times more cash coverage than we need to make our debt service payments.“

"There are three fail-safe mechanisms in place to ensure that debt service payments are made in full and on schedule.”

"Going back as far as the Great Depression, California has never -- ever -- missed a scheduled payment to a bondholder or a noteholder. Not during the recession of the early 1980s. Not during the collapse of the defense industry in the early 1990s. Not during the dot-com collapse of the early 2000s. And not now. And we, along with the Treasurer and the Controller, will continue to ensure that this streak will never be broken."

I am not alone in being taken to the state woodshed. More recently, Lloyd C. Blankfein, Chairman of the Board and CEO of Goldman, Sachs & Co. received this letter from Lockyer’s office, a letter that was ridiculed by The Financial Times’ Spencer Jacob here.

Once you get past the name calling, California has two arguments. One argument is that California has never defaulted; therefore it will never default. This is, of course, absolutely absurd, insulting our intelligence. Every person, corporation or other entity that has ever defaulted on a loan has been able to say, at least once, that they have never defaulted. As they say in finance: Past performance is not a guarantee of future performance.

California’s second argument is that it has both a constitutional requirement to meet certain debt payments and the cash to do so.

That’s nice.

I have no idea what a constitutional requirement to meet debt payment means, but it doesn’t mean that California will always pay its bills. California has a constitutional requirement to have a balanced budget every June. That constitutional requirement is ignored almost every year. It was ignored last year. It will be ignored this year. It will be ignored next year, unless the Feds have bailed out California, relegating the state’s legislature to rubber-stamp status.

California’s constitutional requirement to meet debt payments will mean nothing when the state’s financial crisis comes. It won’t mean anything if a debt issue or rollover can’t be sold. It won’t mean anything if the state has no cash, and banks refuse to honor California’s vouchers.

The relevant analysis begins with the recognition that California is too big to fail, which means it will fail.

Since there is no procedure for a state to file bankruptcy, the solution to California’s financial crisis will be chaotic. What does it look like when the government of the world’s eighth largest economy can’t pay its employees, or pay its suppliers, or meet its obligations to school districts, counties, cities or other local government agencies?

It looks ugly, ugly enough to have huge economic ramifications far beyond California’s borders. It looks ugly enough to mean that California is too big to fail, and that’s why we will have a financial crisis.

Once something (a bank, a car manufacturer, a state) is too big to fail it has perverse incentives. A moral hazard is created because of the free insurance. In California’s case, the moral hazard is exacerbated by a system that assigns responsibility to no one. The super-majority requirement means that both parties will escape blame, and the required cooperation of the legislature will absolve the governor. The governor will blame the legislature. The Republicans will blame the Democrats. The Democrats will blame the Republicans. The citizens will blame the political class. Talking heads will blame an allegedly fickle electorate. Everyone will point fingers, but the blame will not settle on anyone.

In the end, blame will not matter. No one in a position of power in California has the incentive to make the tough decisions needed to avoid a crisis. So, no one will. Indeed, at this point everyone has an incentive to not make any hard decisions. A bailout from the Feds will be a wealth transfer from the citizens of other states to California’s citizens. The incentive is to drag things out, to appear to be working on the problem, to maximize the eventual windfall.

I’d love to see California’s political class show some leadership, step up, and effectively deal with the state’s financial problems, but that really is unlikely, requiring as it will, tough decisions on spending priorities and taxes and foregoing a windfall. Ultimately, money usually trumps character.

Bill Watkins is a professor at California Lutheran University and runs the Center for Economic Research and Forecasting, which can be found at

Photo by pirate_renee

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This is nothing new.

From the sounds of it you'd think California is about to implode and this is suddenly a new phenomena. The reality is that California's decline took over 30 years, or the time period that has passed since Proposition 13 was created. Ever since then the state's tax income has fallen as the population ages. The result has been a slow but sure erosion of public schools, roads, and infrastructure. Long-time residents have simply changed to accommodate. As it is now, the state is more like a 3rd world country. Very little middle class and a whole ton of really rich and really poor people with the rich essentially bankrolling their public schools.

califa default

Remember well these words of wisdom from ages past:

Believe NOTHING until its officially denied.

we have official denial all over the joint in this article.
very vociferous denials.

and if there was no problem, would these dipsy doodles bureaucrats care what some columnist/ivory tower professor (apologies....its to make a point) has to say? answer: not really.

thus, on that basis, what we think to be true, is.

califa is a failed state. I have read that it is in worse shape than greece, and while greece is just 3% of the euro, Califa is the worlds 6th or 7th largest economy. thus a much larger impact on the US as a whole. can this state be saved, asks the ladies home journal.

it is not if, just a matter of when, it is generally recognized as a failed state.

which is one reason the borders to the south are open.
the need for more peons (sic) to tax.

do you not think we could secure the borders if we really needed to?

nope, its a deal where cheap labor and drugs come north and $50+ billion a year goes south. everybody wins.

and Mexico is now just another narco state, just like afghanistan. (what, you thought we were there to give democracy and free choice to the little brown peoples in their poppy fields. the taliban had eradicated the problem and now its bigger than ever)

and the smart productive middle class tax payers are fleeing CA as fast as they can.

but also, think about this: at some point your average southern california Mexican who is being taxed to support old white people on sociable (sic) security in connecticut is going to ask why he/she should continue doing so. they have no reason to pay into a bankrupt system from which they will never see a return and to which they have no commmitment. they are Mexican, not US. their loyalty is to mexico. misplaced perhaps, but there it is.

at that point, you will have your reconquista.

and say what we will about immigrants, legal or otherwise, it takes a special type of person to leave his/her family to go to a new country and take up arms against a sea of struggles. they have a tendency to be free thinkers and generally smarter than the average bear.


in other news, as the dollar collapses: buy gold and hold it in your hands.


The name of the image is: california-capital-1.jpg
It should be: california-capitol-1.jpg
It is a photo of the capitol building.

Dave Barnes

California has already

California has already defaulted. I don't what they are talking about. How many of us could get away with paying our bills in IOU's? If California were a person or business, it could have been forced into involuntary bankruptcy.