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Wednesday March 10, 2010 - 18:27:21 GMT
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California Dreaming more like Fiscal Nightmare

California Dreaming more like Fiscal Nightmare


As an alumnus of the great baby boomer migration from the East Coast to the West Coast in the 1970’s (Long Island to Berkeley) on the belief that weather, D, S and RnR would be a far better experience in the Bay Area than in the Great South Bay, 35 years on from the onset of great migration the California Dream of the 60’s and 70’s is looking more like the California Nightmare.  BTW I made it out early – 1985.


The BLS today listed California’s unemployment rate in January at 12.5%, up from 12.3% in December and only just less than Rhode Island, South Carolina and Nevada rates (Puerto Rico, a territory as opposed to a state, leads at over 15%). 


Droughts are the norm (population needs far outstrips the water supply, even in a rainy, snowy winter).  Farmers are facing serious water shortages and leaving fields fallow.  A drive through the Valley reveals all sorts of signs posting “New Dust Bowl from US Congress” which farmers claim is more interested in preserving some species of fish the size of one’s finger than the state’s agricultural interests. While the Valley is not home to a huge population, it has been home to its share of the boom in population and housing booms.


Apart from the tech sector, the engine of growth in the state is the prison system…the new factories in the fields (of Sacramento Valley), 33 in all. 


The budget deficit in the state is forecast at $20bln for 2010 (though government is forecasting $14bln), about what it was in 2009.  And this despite massive cuts in state programs including Medical, education and infrastructure. 


The state legislature is more dysfunctional than the US Senate, requiring super majorities to raise taxes and assuring permanent gridlock on most budget issues.  Governor Schwarzenegger’s approach to the budget gap funding problem when he was first elected to office was borrow long to pay for short-term debt expirations and currency expenditures.  This was unsustainable short of an elevated growth rate in the state and the Great Recession has been no greater than in California


So I read with special interest today’s WSJ article on the state’s budget crisis and in particular the tuition increases at the University of California system – 32% tuition increase has prompted a state-wide rash of student protests reminiscent of government workers lashing out against austerity measures in Athens.  Sather Gate on UC Berkeley campus, which I walked under daily as a student there, is the photo journalist’s preferred shot of student protesters.  And tuition and fees are now $10,300 a year up three fold from 1999 and up from $636 a year when I was enrolled.  The students are complaining that the cost of state public education is now on par with private post-secondary education.  In other words the social subsidy, aimed at allowing less advantaged students to afford a quality university education, is largely gone.  The reality is quite different than the claim to social equalizer for UC system…enrollment in the best universities in the UC system has always been largely dominated by students who could afford to pay private level tuition and fees paid for the average tax payer who could not afford and mostly can’t qualify to get into the most competitive campuses in the system.  What has gone away for the UC system (clearly there is a real need for a number of educationally gifted and income constrained students), is a subsidy for higher income families paid for by those who mostly never consume directly the benefits (sending their kids there) of the UC system. 

If the higher education subsidy story is not enough to cause the hair on your neck to stand up, then look at what the great state of California is doing for its state’s first responders retirement benefits according to the WSJ today.

“The California legislature? Good luck with that. In 1999, the Democratic legislature ran a reckless gamble that makes Wall Street's bankers look cautious. At the top of a bull market, they assumed their investment returns would grow at a 8.25% rate in perpetuity—equivalent to assuming that the Dow would reach 25,000 by 2009—and enacted a huge pension boon for public-safety and industrial unions.

The bill refigured the compensation formula for pension benefits of all public-safety employees who retired on or after January 1, 2000. It let firefighters retire at age 50 and receive 3% of their final year's compensation times the number of years they worked. If a firefighter started working at the age of 20, he could retire at 50 and earn 90% of his final salary, in perpetuity. One San Ramon Valley fire chief's yearly pension amounted to $284,000—more than his $221,000 annual salary.

In 2002, the state legislature further extended benefits to many non-safety classifications, such as milk and billboard inspectors. More than 15,000 public employees have retired with annual pensions greater than $100,000. Who needs college when you can get a state job and make out like that?

In the last decade, government worker pension costs (not including health care) have risen to $3 billion from $150 million, a 2,000% jump, while state revenues have increased by 24%. Because the stock market didn't grow the way the legislature predicted in 1999, the only way to cover the skyrocketing costs of these defined-benefit pension plans has been to cut other programs (and increase taxes).

_This year alone $3 billion was diverted from other programs to fund pensions, including more than $800 million from the UC system. It is becoming clear that in the most strapped liberal states there's a pecking order: Unions get the lifeboats, and everyone else gets thrown over the side. Sorry, kids. “

The state also has a very active proposition legislative channel that more often than not allows special interest groups to amass enough signatures and run ad campaigns to get fiscally imprudent laws passed…recall Proposition 13 of the late 1970’s that stripped government of raising real estate taxes unless a property is sold (property tax rate adjusts to the new owner and home price)…this one crippled the educational system at the time until the government responded with borrowing more in the debt market to fund itself.

Is there CDS market for California state bonds and muni’s?  If there is a CDS on state paper I would be a buyer.  California’s fiscal position is every bit as bad as Greece’s and increasingly facing a similar set of choices and constraints …massive spending cuts and tax hikes (assuming they can be passed), higher borrowing costs and sub-par growth.  The crisis is here.  I just wonder when markets and US government debt will reflect this implicit guarantee.

David Gilmore


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