The U.S.-Mexico frontier has always had a certain romantic image as a place where bank robbers, bootleggers, and other assorted ne’er-do-wells could escape the law by slipping across the border into Mexico.  But California Governor Schwarzenegger now views our neighbor to the south as a destination for criminal after they are caught, tried and sentenced:

Schwarzenegger suggested California could ease its crowded prison system by sending thousands of undocumented inmates to specially built jails in Mexico.  Speaking to reporters at the Sacramento Press Club, Schwarzenegger said California could ease its strained finances by a billion dollars if 20,000 illegal immigrants currently held in the state were housed across the border.
“I think that we can do so much better in the prison system alone if we can go and take, inmates for instance, the 20,000 inmates that are illegal immigrants that are here and get them to Mexico,” Schwarzenegger said. (Click here for full article)

This isn’t the first time California has  tried “outsourcing” its prison population.  The state has sent inmates to Michigan, for example.  This is, however, the first time the state would be outsourcing and offshoring its corrections obligations.

We have doubts about the feasibility of the plan, but we find the plan itself interesting and indicative of how truly desperate the Golden State’s fiscal position is.   There simply is not enough money to go around at the moment, and the Governor is making an attempt to think “outside the box.”

In the months and years to come, as California struggles to put its house in order, we would expect to see an increase in…shall we say…”unorthodox” solutions.

It reminds me a little of Jonathan Swift’s “Modest Proposal“  in which, as a solution to the Irish famine of the 1720s, Swift recommended that the Irish eat their own children.  Swift was writing a satire, of course.  His goal was to shock policymakers into taking action.  Perhaps the Governator has similar motivations.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

This is a follow-up to Rodney Johnson’s post today on state finances.  In the Wall Street Journal, we read today that “More Pain for State’s Taxpayers, Cities” is on the way.  The Journal writes,

The cost of shoring up Calpers, the troubled $200 billion pension fund for California public employees, will ultimately fall on the state’s 38 million residents, who are already dealing with tax increases and reduced public services.

The state and local governments are contractually bound to increase their payments to Calpers to help it make up for its investment losses of more than $50 billion in the fiscal year ended June 30.

California already had to spend $3.3 billion from its stretched general fund in the last fiscal year to make up for Calpers poor investment performance.  Cities and counties too have had to pour new monies into the fund at a time when they can scarcely afford to pay the electric bills in their offices.

There is no easy way out here…and green shoots or not, California’s problems are just beginning.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

California is in the process of selling $8.8 billion worth of notes that come due next May and June.  That would seem unusual given that just last fall the state couldn’t sell bonds, recently the state had to pay vendors with IOU’s, and starting in November the state will forcibly “borrow” money from taxpayers by over-collecting income tax which will be repaid in 2011.

So why is the sale of notes going so well?  Because the state is paying over 100 basis points more than other state issuances, and is paying 130 basis points more than comparable treasuries.  Now this probably would not persuade a sophisticated investor, since 100 basis points is merely 1%, but the state of California went further.  They advertised.  Using a multimedia campaign that involved radio and newspaper, the state sold itself to individual investors not only in California, but also in Texas and Florida.

For good measure, Moody’s and S&P gave the notes their highest rating.  I’m sure that’s very comforting, unless you are well aware of the quality of these rating services over the past several years.

Clamoring for California Debt

http://online.wsj.com/article/SB125362502390330681.html

Turns out people in CA really are creative…not just in Silicon Valley, but in Sacramento as well.

SACRAMENTO, CA - Come November, you may notice your paycheck is a bit smaller. As part of the state budget fix, lawmakers are “borrowing” future income withholding taxes in order to raise $1.7 billion for this fiscal year.

“It’s not raising taxes. It’s just getting the money, borrowing from you for a short period, non-interest bearing, and you’ll get it back later,” explained Sacramento accountant Ken Astle.

Astle said that taxpayers can file a DE-4 form to change withholdings and increase exemptions to compensate for the extra withholdings.

Taxpayers will get their money back come tax time in 2011, unless they underpaid their withholdings.

In addition, the state is also requiring individuals and business that make estimated tax payments to pay more earlier - another accounting move that is designed to help the state balance its budget this year.

Critics charge that the state is only delaying the task of balancing the budget without accounting gimmicks.

http://www.news10.net/news/local/story.aspx?storyid=64236&provider=top

H/T Cal Garvin for pointing this out!

With all the talk of economic recovery — even in these pages — we think it’s a good idea to keep things in perspective.  Yes, nationwide, things are getting less bad.  But the aftermath of the property bust will be with us for quite some time, particularly in Southern California, where there was overbuilding of practically everything — houses, retails, offices, you name it.

This WSJ headline pretty well sums up the situation: “Vacancies Suppress Southern California Recovery.”

How  bad is it?  Office vacancies in San Bernardino and Riverside counties have more than tripled, rising to 24.6% from 8% in 2006.   Orange County’s office vacancy rates stands at a comparable 20%.   The Inland Empire’s retail vacancy rate has more than doubled to 10.6% from 5% in 2006 (and will likely rise further in the sluggish consumer environment we see ahead).  Anecdotal reports tell of new office buildings sitting completely empty and shopping malls defaulting on bank loans.  It is truly a depressing picture. Read the rest of this entry »

The State of California has a balanced budget proposal…sort of.  To close an ever-widening $26 billion gap, the legislature has proposed $15.6 billion in cuts, $4 billion in revenue from sale of property, $3 billion in accounting gimmicks that accomplish nothing, and $2 billion in theft borrowing from local taxes.  Apparently, when the times get tough, the tough pillage their neighbors.

California is using a provision that gives it the ability to forcibly borrow (everyone else recognizes this as stealing, even if you intend to give it back later…isn’t that a joyride in police parlance?) local monies and then the state must pay it back within 3 years.  Nevermind that locales are suffering.  Nevermind that some of the suffering in those locales is being caused by the IOUs the government sent out in lieu of real cash to vendors across the state.  Nope, none of it matters.

Apparently, beyond my thoughts on Monday about consumers being out for themselves when it comes to determining how we run our households, state governments can be out for themselves as well.  Even when it involves ripping off their own constituents so that they won’t have to do the job they were elected to do.

We are almost 2 years into this economic shakeout, and we still haven’t recognized the most basic of notions of where we are - that we must get by on less.  People know it.  Consumers behave like it.  But as soon as we move from private consumers to politicians, we seem to behave as if by some magical force the economic engine of yesterday will come roaring back.  Every day that we beg, borrow and steal in anticipation of this return is another day we have squandered instead of trying to arrive at workable long-term solutions.

On June 25th Charles Sizemore wrote about the impending move of CA to issue IOUs instead of paying their bills as of 7/1.  That move has been implemented.  Now, some big banks are answering Charles’ question with an emphatic, “No!”

The WSJ reports this morning that several of the biggest banks, including B of A, Citi, Wells Fargo, and JPM/Chase were among those that declined to accept the notes.  Apparently this dismayed some state officials, as a spokesman for State Controller Chiang said, “We don’t want anybodty to suffer who can’t redeem them when they need cash.”

It’s really hard to get past the hypocrisy of state that refuses to balance its budget and then refuses to pay its bills blaming banks for refusing to accept the funny paper.

The CA IOU notes mature in Oct and pay 3.75% interest.  Or do they?  What assurance does any holder of these IOUs have that the state will actually cough up the cash in Oct?  Didn’t these same holders, being vendors to the state or some other service provider to whom the state owed money, already get led down the primrose path?

Don’t be fooled, this is a bond offering pure and simple.  Except it was done through force, where the state shoved down the throat of service providers CA issued bonds in the form of an IOU.  Why would they do such a thing?  Because the bond market isn’t so keen on CA paper right now.  In fact the same article notes that Fitch downgraded the state to BBB.

Why issue bonds, going through all of the hassle and trouble with the securities market and their pesky regulations, when you can basically foist your troubles onto your vendors?

Problem solved!  Unless of course, you were one of those vendors who is now stuck with something that nobody wanted in the first place - more CA debt.

Yesterday was the first day of reckoning.  Not in the biblical sense, but in the sense of having to live within our means on the community front.  As July 1, 2009 came and went, 46 states had to begin living with greatly reduced income due to falling tax receipts and anticipated further declines.  So what did legislatures across the country do?  They lived up to their reputations by pursuing a policy of denial.

California (OK, it’s getting old to keep beating on them, but it’s so easy!) has now begun issuing I.O.U.’s in leiu of payments in order to preserve cash.  At the same time, the state is trying to play down the notion that it represents a heightened credit risk.  The governor and several legislators keep repeating, ‘The state of California has never defaulted on a payment.”  Hmm.  I wonder if the recipients of the I.O.U.’s would agree.  Last time I checked, if I were to send my mortgage company/credit card issuer/utility provider an I.O.U. they would promptly send me back a late payment notice and eventually a default notice.

California of course is not alone.  Many states have deficits and I believe seven are still unsettled in their budgets even though the deadline has passed.  However California has the biggest gap and is one of the biggest deniers of the basic principles of accounting, so it is worth continuing to point out their bizarre statements.

It seems a universal truth that we must spend less in the days ahead while working to deleverage our economy at every level.  This is a self-chosen situation, where we as consumers and citizens spent more over the last 25 years and are now choosing to spend less and save.  It’s not bad in a moral sense, but it is painful.  In order to achieve balance, there must be cuts.  Big ones.  And yet the very people we put into positions of political power (and we pay very well, by the way, with straight income and very generous benefits) are unwilling to do the tough part of the job.  It’s easy to spend more.  It’s easy to create programs with other people’s money.  It’s hard to cut programs that by-and-large go to assist the least among us.  But, to paraphrase Willy Sutton, that’s where the money is, so that is where each level of authority, from cities up to the US government, will have to look for cuts.

This is the time where we live up to the rallying cry of “Don’t burden our children with this debt.”

A quick note on the state that just can’t seem to get out of its own way:

Reuters reports: “California Set to Issue IOUs as Fiscal Crisis Weighs.”

“California’s controller said on Wednesday that he would have to issue IOUs in a week if lawmakers can’t quickly solve a $24 billion budget deficit, and the state’s treasurer plans to tap a reserve fund to meet debt service costs.”

Writing IOUs to pay the bills and meet debt service costs….  This won’t end well.  Californians, one way or another, are about to get hit with a large tax hike even while their state services are cut.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Facing an unprecedented budget crisis that never seems to end, Illinois has had to cut spending in some rather drastic ways.  The state announced that it would have to stop paying for about 10,000 funerals for the poor.  When a state lacks the funds to bury the dead, times must really be tough.

This was one of many difficult cutbacks listed by the New York Times earlier this week (”States Turning to Last Resorts in Budget Crisis“).  Some other cutbacks of note:

• In Hawaii, state employees are bracing for furloughs of three days a month over the next two years, the equivalent of a 14 percent pay cut.
• In Idaho, lawmakers reduced aid to public schools, forcing pay cuts for teachers
• In California Gov. Arnold Schwarzenegger has proposed releasing thousands of prisoners early and closing more than 200 state parks
• New Hampshire wants to sell 27 state parks

In addition to the cutbacks, new tax hikes have been proposed on everything from cell phone ring tones to candy.

“Green shoots” or not, it is obvious that the states are still very much in a state of crisis.  The banking and credit systems might have returned to something close to normal (or at least they are moving that direction), but state and local governments still have a long process in front of them.   They spent freely and recklessly during the boom years.  Now, in the bust, they have to learn to make do with smaller, less ambitious budgets.   This is not the kind of thing that gets fixed overnight.  Expect this state of crisis to linger for quite a long time.

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy