California’s ‘Undeclared Bankruptcy’: It’s More than a Budget Problem

Diane Harkey Board of Equalization Member Diane Harkey Leave a Comment

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This op-ed originally appeared in the San Diego Union-Tribune

Upon being sworn into the California State Assembly in December, I promptly met with staff from the Governor’s office, Department of Finance , Controller’s office and others to assess the State’s fiscal crisis.  Also, I did what I hear is unthinkable for an elected official – I reviewed the State’s last bond offering prospectus (July 2008), the Comprehensive Annual Financial Report (FYE 2007) and current debt schedules. The information is available to the public, in writing for anyone who cares to read – the State of California has more than a budget problem, we are in a state of undeclared bankruptcy.

To digress, the State has had a budget problem for years.  A budget is a year-to-year anticipated revenue and spending plan tracked on a quarterly basis, using detailed, technical forecasting.  If there are shortfalls or overages, the State may make mid-year adjustments.  Short-term borrowing from banks is usually available to fill a temporary shortfall. For instance, the State is typically short on cash twice a year while awaiting receipts from property, sales and other tax revenues.  The State borrows short-term using RANs (Revenue Anticipation Notes), which are repaid as soon as the tax receipts arrive.

Compare this to a family that counts on receipt of a semi-annual bonus to help pay property taxes. The property taxes are due by December 10th and April 10th, but the bonus arrives in January and July.  The family might decide to use a credit card (short-term debt) to bridge the gap.

However, if the family’s credit cards are maxed out, and they need cash, what do they do? They might take out an equity loan on their home to be repaid over time. This is similar to what the State did in 2004 when the voters approved the Governor’s request for $15 billion in Emergency Revenue Bonds.

Then, let’s assume that one of the family’s income earners loses his/her bonus or job, similar to the state hitting a recession.  The family was living month-to-month, as many families are these days.  They needed the bonus and/or second income to stay afloat financially and repay the mortgages on their home.  Our State was likewise living month-to-month, spending every anticipated dollar, and then – crash – the stock market tumbled, people lost jobs, incomes declined, homes went into foreclosure, and in essence the State lost its ”bonus” or second income.

The hypothetical family noted above, could try to reduce expenses, make arrangements with lenders, or as a last resort, even file for bankruptcy protection while they work things out. The County of Orange, you may recall, filed for bankruptcy protection just over 14 years ago, and managed to work with its creditors for a solution.  However, States cannot file for bankruptcy protection like people, businesses, cities and counties.  Also, States cannot print money like the Federal Government (as it currently is doing by the boatloads).

The problem we face in the Sacramento is not ”partisan bickering” in the legislature – it is that the real problem is either not understood, or not being addressed by other than a few ”under the dome”.  The reality is that even if the parties did agree on new taxes and spending cuts, the bankruptcy dilemma would remain without true reform.

Certainly, we must learn to live within our means on an annual basis. The Democrats suggest raising revenue (a.k.a. taxes). Republicans believe reducing expenses should come first.  The Governor and even some Democrats agree on spending cuts or a combination of both taxes and cuts to solve any future ”annual budget” issues. Our creditors (Banks and Bondholders) really don’t care what course we take – they just want assurance of repayment.

However, with a potential $41 billion shortfall looming in the future, credit markets and lenders also want to see a package of real fiscal reforms, so they know we are serious about fixing our structural deficit – before they will lend to us for anything again.  We need their help in the near-term and we must improve our ”junk-bond” credit rating to do so. This is one of the reasons the Governor vetoed the latest Democrat Budget.

The Governor and the Republicans have proposed a variety of sound reform measures, reserve requirements and a spending cap that I support.  However, we have $66 Billion in ”voter approved” bond debt yet to be funded. Add that to the $43 Billion outstanding and you can see that with the state’s priority of funding, this future debt could drown out our ability to fund other services we expect government to provide. Therefore, we should go one step further and reform our business practices and debt/bonding procedures.  Speaking as a former Banker, a little discipline in the State’s finances would be a good thing. It would be nice to know our borrowing limitations, before our banks and financial partners cut us off.

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