California's Credit Cut
As we forecast a few weeks ago, Fitch Ratings chopped California’s credit rating to BBB this morning, “based on the state’s continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis.” BBB is just two levels above “junk bond” status.
Still unable to resolve its $26 billion budget shortfall, The Golden State started issuing IOUs to its creditors last week for just the second time since the Great Depression. Fitch’s downgrade will make closing that budget gap even more challenging.
“State governments will have a negative impact on GDP in coming quarters,” writes Dan Amoss, our resident CFA and editor of Strategic Short Report. “In the next few payroll reports, we’ll start to see these budget crises lead to larger job losses in the government sector.
“These budget crises were seeded when state governments started spending on the naive assumption that the real estate bubble and windfalls from capital gains taxes would never end. They hired new employees in droves over the past decade on the assumption that tax ‘revenue’ was sustainable. According to Michael Mandel of BusinessWeek, the public sector of the U.S. economy created 2.4 million jobs over the past decade — twice as many as the private sector
“Now California is preparing to pay its bills with IOUs. Eventually, some government jobs will have to go.
“U.S. taxpayers will likely extend a lifeline to California’s bankrupt state government before the end of summer. At a May 21 hearing in Congress, Rep. John Culberson of Texas asked Treasury Secretary Geithner if he would ‘rule out bailing out California or any other states with our tax dollars.’ Geithner replied, ‘We will have to do exceptional things, as we have done already, to fix this mess. That’s not putting on the table or taking off the table any specific thing like that.’
“Translation: a bailout will likely arrive if California’s budget is in danger of a chaotic collapse, but it will have to come on tough terms. The Treasury will probably provide a bridge loan on the condition that California’s government quickly pay back the money with fiscal austerity measures. Why the tough terms? Because after the recent moonshot in 10-Year Treasury yields, even Secretary Geithner is learning that the market will impose limits on the federal government’s deficit spending.”
Geesh, California can’t even afford a proper send-off for the King of Pop. Thousands upon thousands will rush into the Staples Center in Los Angeles today for a memorial to Michael Jackson. Between keeping extra cops and medics on hand, to traffic control, to post-event cleanup, the city of Los Angeles will spend around $2 million on the memorial… money, of course, it doesn’t have.
“I did reach out,” acting LA Mayor Jan Perry said. “I said, ‘Is there any way to direct me to people who can assist, in Michael’s memory, in deferring the cost of this event? I’m still waiting for a callback.”