California is Bankrupt

Originally posted at BullionBullsCanada.com

For the past several years an increasing number of economic commentators have been warning about the “looming bankruptcy” of the state of California. Well, we can stop writing such commentaries, because California’s bankruptcy is no longer merely imminent, it is here.

Once again I will make my case by beginning with definition of terms. “Bankruptcy” is defined (by Wikipedia) as “a person or an organization that cannot repay the debts it owes to its creditors”.  Some will seek to define bankruptcy in more stringent terms, specifically that formal “default” is required to confirm such bankrupt status.

The fact remains that a debtor who can’t repay his debts will default, all that is uncertain is the timing. Thus to suggest that California is “not bankrupt” simply because formal default has not (yet) occurred is merely an exercise in both circular reasoning and semantics. To make my case that California is “bankrupt” all that I need to do is demonstrate that default has now become inevitable. That will not be difficult.

The starting point here is to (once again) shatter the utterly ridiculous myth that U.S. states and municipalities run “balanced budgets”. For those who have not yet abandoned this nonsensical fantasy, here’s a question for you: if California’s state and municipal governments have been running “balanced budgets” year after year, how can it be that they collectively owe more than $100 billion in debts (not counting countless billions more in “unfunded liabilities”)? Indeed, how could we even be discussing “bankruptcy” with entities which supposedly balance their budget each year?

Being able to borrow as much as you want to spend is not a “balanced budget”. It is nothing but the most painful example of “deadbeat math”, and it can be traced to another popular American misconception: that the U.S. “sells bonds”. A bond is nothing more than a category of loan. When the U.S. claims it is “selling bonds” this is every bit as absurd as a new “homeowner” claiming that they “sold their mortgage” to a bank. Claiming that one can “balance a budget” by “selling bonds” is in fact a double oxymoron (or “moron squared”).

We have now established that California is a chronic debtor, which never balances it budget. We are making progress. Now all that I need to show is that it is utterly incapable of repaying those debts. Unfortunately this is equally simple.

The most telling evidence is the anecdotal examples cobbled together over the past several years of California’s dysfunctional legislature trying to scrounge-up enough dollars to avoid debt default in the current fiscal year. Every year we see the same farce: token spending cuts, ever more unrealistic revenue projections, and then still some sort of fraudulent conveyance has been required to “close the gap” with respect to the last, few $billions. Here we can identify California’s favorite form of debt-fraud: “revenue anticipation warrants”.

The concept of this act of fraud is simple: California is issuing yet another form of “promise to pay”. Yet in this case, instead of flogging more, worthless “bonds” the state deliberately chooses to give this debt instrument a different name “revenue anticipation”.

The implied premise here is unequivocal: that California will be able to repay this debt with “surplus revenues” from the future. Note that the only way in which these warrants are not openly fraudulent is if there are surplus revenues. Obviously if there is no “surplus” then these are not “revenue anticipation warrants” – because what the state will do when those warrants are due is (try to) borrow more money to pay off those warrants.

In fact, since California will never/could never have any “surplus” revenues to pay off these warrants they are nothing but a blatant fraud. In the “real world” we already have a term for such fraud: “kiting a cheque”. It is the last resort of all deadbeats – just before they declare bankruptcy.

Apart from this blatant act of deadbeat-fraud, we have two other equally bleak, equally certain indicators of California’s bankrupt status. A Bloomberg article which actually tries to “pump” California’s muni-debt market supplies us with all of the damaging data we need.

First Bloomberg tells us that state and municipal governments in California are only able to borrow half as much as they could just one year ago. With both the state government and countless municipal governments already teetering on bankruptcy, and with all these governments having huge, structural deficits, this one number alone is “terminal”. Unless creditors suddenly and capriciously reverse themselves here, the inability of California’s deadbeat governments to borrow enough money implies bankruptcy in the immediate term.

If this wasn’t dire enough already, Bloomberg informs us that after the first month of this new fiscal year that state revenues are already running 10% below projections. This directly implies yet more $billions in unfunded (unfundable?) debt. However, keep in mind a more general statistic which I noted in a previous commentary: U.S. withholding taxes suddenly turned negative this spring. In other words, the amounts deducted from peoples’ pay-cheques to pay their tax bill has suddenly started falling.

This is an unequivocal indication of falling incomes in the months ahead, since withholding taxes are calculated based upon anticipated future revenues (i.e. wages). What this means is that we can expect California’s revenues to fall drastically short of projections every month, and with the U.S. economy now clearly weakening at a rapid rate, this revenue-gap will almost certainly increase dramatically.

Let’s summarize California’s predicament. First of all the state has already descended to the level of deliberately/intentionally “writing bad cheques” simply to prevent immediate bankruptcy. It’s creditors have suddenly only shown a willingness to front half as much money as one year ago. Meanwhile its incoming revenues would not be sufficient to pay its bills even if its ability to borrow was the same as ever.

There are no “clever maneuvers” which can extricate the state from its imminent plunge into formal bankruptcy. State politicians have demonstrated they are politically, ideologically, and legally incapable of doing anything to raise revenues. Similarly, this same “gridlock” prevents anything more than token spending cuts. Short of a bout of “temporary insanity” no creditor (anywhere in the world) is going to want to lend to this deadbeat at previous levels (or current interest rates).

Understand that thanks to the magic of “compound interest” that (like all debtors) California’s state and local governments must come up with not merely equal amounts of revenue, but even more revenues than in the previous year – to pay the additional interest on its debts. Yet as we see, the state is bringing in much less revenues at the same time its ability to borrow has plunged by 50%.

This makes the situation crystal-clear: the only way in which California can delay bankruptcy year-by-year is to keep writing bigger and bigger “bad cheques” – and then hope that no one “calls it out” with respect to such blatant fraud. More simply, California is bankrupt.