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alstry (36.34)

California in HUGE trouble

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August 03, 2008 – Comments (9)

Probably more than any state in the country, CA generated a greater absolute and relative percentage of revenues from the real estate boom. 

CA was the home to the subprime industry.  Something like 1 in 10 residents held a real estate sales license.  The rise in property values generated enormous increases in property taxes.   The rise in new home constuction created a boom in jobs, permit fees, ect... 

CA became accustomed to the higher revenue base and spending grew dramatically at the state, county and local level.  Same with the business and individual levels. 

The problem is those revenues were created by simply borrowing money that many couldn't afford to borrow and unreasonable expectations.  Now the revenues have evaporated in just about a year but the debt remains.  The effect is violently rippling through the economy. 

We saw four retailers with strong exposure to CA go bankrupt in July:  Mervyn's, Steve and Barry's, Bennigans/Steak n Ale, and Shoe Pavillion.  Repeatedly, other retailers are feeling the effects such as HomeDepot and Starbucks.

Now we have large commercial vacancies where mortgage companies once occupied.  Vacant shopping centers, and schools in the middle of corn fields, where homes were to be built.  Incomes for probably over a million people in CA have simply evaporated just factoring real estate sales people, construction workers, and mortgage employees and others directly related to the RE industry.

The revenue CA became accustomed to is simply gone and its government, businesses and residents borrowed billions against expectations that will never materialize.

The boom this time created much more revenues and debt than any of the previous booms.  Its the margin or debt that will be the BIG issue.  The fall out from trying to deal with it is going to be much more severe. 

CA simply has no way to reasonably service its debt without MASSIVE changes.  MASSIVE CHANGES.

In the end it was simply a ponzi scheme.  We kept letting people borrow money they couldn't afford to pay back forcing the price of real estate up to higher and higher prices.  Each time a transaction was made,  money spread around to the sales people, mortgage companies, banks, government, retail stores ect.....  Property taxes exploded.

Now that money is gone forever.....but the debt remains....a HUGE amont of debt....more than ever before in CA history.

There is little doubt at this point that dealing with this will be difficult.....very difficult.  Now the question will be to what extent will sacrifices be imposed between the residents and financial system?

You simply can't tax your people more....the incomes for many is gone.  Same with business.  The leaves budget cuts...and the dollars are HUGE. 

Clearly the fireworks are about to begin....and it will not just be CA.

 

9 Comments – Post Your Own

#1) On August 03, 2008 at 9:37 AM, alstry (36.34) wrote:

At this point, there is only about $6 trillion of deposits in our nation's banks.

There is likely well over $30 trillion of residential estate loans, commerical real estate loans, consumer, commercial and municipal loans identified as assets in our nations pensions plans, banks and insurance companies.

Much of this debt was incurred over the past five years, highly leveraged, and was directly or indirectly related to the real estate boom.

Now the debt is defaulting and the assets are evaporating destroying banks' and insurance companies' balance sheets.

At this point, the defaults are just beginning...we are only about a year into it and as savings is spent down more defaults will inevitably follow.

It is a mess and is now about to get much messier.

Hopefully this helps explain why I have used the condo example in the past.  Even if you pay your fees and are responsible, if enough of your neighbors fail to pay, the whole condo association fails.

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#2) On August 03, 2008 at 12:51 PM, dexion10 (27.84) wrote:

Alstry I 100% agree that California is in MAJOR TROUBLE.

I've focused my bank shorts on California because there are just a myriad of issues out there. 

But to your point I'll give you another data point. Ryland Homes is pulling out of California and they said they have no plans on returning within the next few YEARS because they see california as a state with substantial infrastructure problems which they don't have the money to heal.

Basically Ryland said they think California is a disaster that will linger for the foreseeable future.

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#3) On August 03, 2008 at 4:23 PM, zygnoda (26.90) wrote:

What do you think about DemonDoug's comments on your last post?

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#4) On August 03, 2008 at 4:58 PM, DemonDoug (32.84) wrote:

I'll just repost it.  From the previous blog:

al, i remember reading on another forum about a game called simcity 4, where the only way you could lose is by letting debt get out of hand.  Like once the debt got above 50% of your city's domestic product, you entered a debt spiral that you could not get out of.

seems like that's what you are saying is happening to CA (along with many other businesses).

I think you are still underestimating the power of the banks to inflate.  It would only take a simple act of congress to allow the Fed to basically say "Every dollar today is now worth 50 cents" and devalue the dollar by 50% on the spot.  In essence this is what they have been doing, but over a 3 year period.  I expect a further 50% dollar devaluation over the next 2-3 years.  This keeps us solvent, and keeps the game going for the banks.  Neat, huh?  The only way this changes is if Congress grows some hair on their balls and forces the charade to end, but oh, what's this?  300b ag, 168b stimulus, 300b mortgage bailout - yeah congress is really gonna force the fed to stop printing money.  Not damn likely.

Thing is al, even though you are more bearish on the markets, this is where I feel I am more pessimistic overall.  You expect a systemic collapse.  I don't.  I expect the banks to maintain and even possibly gain power from all this toxic debt.  Sure, many will go belly-up, but not as many as you expect, and not as many that should be dead.  Just look at WCI and SPF - these guys have been insolvent for over a year now.  Yet the game is still going.   I expect efforts will continue to devalue the dollar and the system to go through superficial changes at best, wheras it seems as though you are looking for wholesale changes.

While I WISH that I could foresee wholesale changes, because it would be better for the USA and the world as a whole, I don't see that happening.  This is why so many people are advising to buy gold and silver - because they see the banks continuing to devalue the dollar to save their own a$$e$ and to maintain the system that has made bankers insanely wealthy.

 

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#5) On August 03, 2008 at 7:03 PM, alstry (36.34) wrote:

Demon,

At this point, debt is defaulting at an accellerating rate.  Debt is an asset on the books of banks, insurnance companies, and pension funds.

I simply don't see the fed writing checks for trillions of dollars to the above.  Absent that, debt is defaulting at a much faster rate then the Fed is printing.

Hundreds of billions to keep banks solvent....sure.  Trillions....I doubt it because of runaway inflation and there is a wage arbitrage containing income.

Remember, in the seventies when we had inflation....wages rose with prices.  Inflation today would be the total destruction of America as we know it....especially in light of our aging population on fixed incomes.

 

Recently, we were having about one retailer per month going bankrupt for the first half of the year.  In July, we had four fairly decent size bankruptcies.

My guess is that bank failures are going to start ratcheting up in August as well.

Right now it is practically impossible to get a commercial loan.  That is not inflationary.  Let's see what happens Tuesday when the Fed meets.

 

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#6) On August 03, 2008 at 7:08 PM, alstry (36.34) wrote:

Following up on California:

My estimate is that CA tax revenues are going to decline approximately 30% due the the credit crisis and real estate implosion.

If CA fires all of its employees, it can't make up that amount of shortfall. 

In addition, a significant percentage of the people who were paying high taxes(real estate sales people and mortgage brokers) are not making a dime today and not paying taxes.  You can't tax someone who is not earning an income.  Thus, CA has relatively fewer people to raise taxes to collect higher revenues.  In addition, it has lost much of its highly profitable mortage and construction industry...you can't raise taxes on those businesses either.

Unable to raise taxes, impossible to cut enough due to constitutional restrictions.....CA faces unprecedented issues ahead.

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#7) On August 03, 2008 at 8:17 PM, DemonDoug (32.84) wrote:

al, I can't remember where you said you lived exactly, but feel free to start using the word "we" when it comes to CA - we both live in this state and will have to deal with any and all ramifications.

Remember there are a lot of other industries in CA - we are still the entertainment capital of the world, including tv, movies, internet/computers, modeling, acting, video gaming, radio.  We also have the ports which keep a lot of people employed along with ancillary support.  Tourism doesn't make people gazillionaires, but hotels surely can, and at least it keeps people employed.  Food and agriculture.  Wine/grapes.  Restaurants.  Clothing/design.  SF and LA are meccas for art and literature. This isn't toledo where if your auto parts maker closes down the entire town has unemployment rise by 50%

The points you bring out are fair and true; overspending and mismanagement has plagued CA for many, many, many years.   I wouldn't be surprised if, as you say revenues drop 30%.  But there are just too many talented and hard working people in this state to have it fall into oblivion like a Michigan has.

Al, I know you are working on a certain assumption about what inflation and deflation is.  For the overwhelming majority of people, inflation is what occurs in the production/consumption economy.  The cost of a MBS, a CDO, credit default swaps, bond insurance, etc, the falling of these, on their own, does not affect prices in the p/c economy.  It's when the credit that is extended to these financial institutions bleeds out into the p/c economy that the world at-large gets hit with price increases.

You also said before money is contracting; if we go by strict M0 to M3 and MZM definitions, you are also wrong.  Yes, credit default swaps and LBO-based asset backed paper is going belly-up; but these are NOT technically part of the money supply.  If the 400trillion CDS market goes completely to zero, I know you would call this deflationary; but me, if the Fed is continuing to raise M2 and M3 through credit supply, and none of that money is going into the CDS market but rather directly to the money supply, you will see inflation in the p/c economy skyrocket.

So yes, if you take the value of all the assets everywhere, including every single ABCP, MBS, CDO, CLO, and credit default swap, things are falling faster than the Fed can print.  But with those things falling, the money has to go somewhere, and if it's not going to paper investments, it's going to go into real assets.  It only takes a small percentage of the money loaned out to make a huge effect on the p/c economy too.

Again we agree on the bottom line tho: CA definitely does face unprecedented issues ahead.  (BTW I agree with all of your negative sentiment on CA; as a realist however that means I see both sides of the coin, and while CA is in a very tough spot, there are some really great things about this state that one cannot discount in a full, thorough evaluation of the situation.)

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#8) On August 03, 2008 at 8:39 PM, alstry (36.34) wrote:

Demon,

M3 and MZM is a small fraction of money supply.  Credit is a much bigger component....not including the deritives you mentioned above.

For example, I put $200K down (from my savings account) on a million dollar house and borrow $800K...even though only $200K would have been counted in the money supply.....the $800K loan spends exactly the same for goods and services as my $200K but little of it gets counted in M3.

Right now there is more outstanding residential mortgage loans than M3.  Add in actual commercial RE loans....and now we have practically doubled M3.

As loans default, the assets in our banks evaporate just the same as if someone withdrew cash out of their account.  As the bank assets contract, lenders refuse to lend forcing depositors to withdraw cash and spend down M3 even further.  This  cycle is just beginning so I am very confident in a few months you will be telling me M3 is contracting......by that time the market will have corrected 30% from this level once the "sophisticated investors" are become aware.

It is a subtle distinction that take some time to understand...it did for me at least.

I know CA is diversified.....but nothing contributed to CA's income in the past five to seven years close to residential and commerical RE.

There is simply no way for CA to recoup the lost revenues from RE...not only that it will likely get worse.  CA is broke and there is not much it can do absent selling off pieces of the State.  Absent a wholesale selloff of state assets, the spillover will be incredible and will impact all of the above businesses you mentioned causing even more slowing.

Initially I was on the sidelines between inflation and depression......now it is getting closer to depression and the mother of all depressions.

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#9) On August 04, 2008 at 3:42 AM, DemonDoug (32.84) wrote:

the problem with your viewpoint is that when you say "deflation" then people assume a strengthening dollar, buying more with the dollar.  Since in all of these scenarios, what the dollar buys is less real assets and more paper assets, it doesn't really help anyone, except the banks that are in power it helps them to stay in power.  If there is a 99% deflation in the credit markets, but a 99% inflation of prices in the p/c economy, does that make it all even?  Hellz no - because everyone has to pay the extra 99% in terms of consumer goods, but only a very few people have to deal with the consequences of FIRE economy contraction.  Unfortunately one of those people are the Fed chiefs and their job is to make sure banks stay in business, so more likely we'll have 100% inflation over 5 years with maybe a 10-20% deflation in the FIRE economy, and about an equal amount in the government economy.

 

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