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JakilaTheHun (99.93)

The Rise and Fall of California

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July 01, 2009 – Comments (26)

The state of California will offer a lot of important lessons from a historical governance standpoint.  it is a state that rose to extraordinary highs and may have some extraordinary lows ahead of it.  Today, Reuters reports that California has missed its budget deadline and will issue IOUs to pay its debts.  This leads to an important question:

How much would you value an "IOU" from the state of California at? 

I know Abitare will probably come by and say $0.01, but look at it realistically.  If you are a creditor or contractor, how much is a $1,000 IOU worth? 

$600?  $450?  $300?  $200?  

The answer probably depends on who you are and what your business might be.  An investment bank might be willing to take on some risk and take an IOU with a huge return in the event that California repays its debts.  On the other hand, if you're a contractor trying to run a business, how do you pay your employees with IOUs that may or may not come through any time within the next 2-3 years.  So in a sense, maybe my predicted answer for Abitare is spot on.  Why on Earth would you take on a very risky IOU if you're worried about paying your workers more than all else?  

 

California and The Decay of American Federalism

You might say that Californian politicians will eventually come to their senses and find a way to balance their budget.  That might be overestimating the capacity of Californian pols to do good, however.  You see, one of my constant critiques of American Federalism is that it's broken at this point.  Not completely so, but it's drifted so far from the Founders' original intent that it bears little resemblance to the system established in 1789.   

Federalism works alright for New Hampshire.  And Vermont.  And Maine.  And maybe some other small states.  It's a complete failure when applied to Goliath states like California, however.  The problem is that democracy just doesn't work on a massive scale.  It never has and it probably never will.  James Madison understood this.  He repeatedly brought up this issue in The Federalist Papers.   The entire idea behind Madison's American system (i.e. "Federalism") was that political power would be decentralized into managable districts (we call them "states").  

The problem is that when you take a massive "district" that is probably larger than France and includes over 10 million people; all of whom are governed by about a hundred legislators and a Governor, then you are asking for corruption.  

California's politicians are corrupt.  They are not there to serve the interests of the voters.  They are there for special interests.  Part of pandering to special interests, however, includes pandering to the voters.  What I'm suggesting is that California politicians are constantly on a quest to give away more things will promising lesser and lesser taxes.  

 

The Property Tax Cap

I could gush on and on about California's overspending.  How the state has recklessly spent money on this and that isn't really necessary, however, because most of that is obvious.  What is less obvious is how the state cripled itself to pay its exbortitant debts.  Spend more, tax less.  But when applied in reality, these conflicting philosophies produce strange results. 

In 1978, Californians passed Proposition 13, the "People's Initiative to Limit Property Taxation."   It sounds great in theory.  Why should you pay higher taxes?  Those damned liberals are just out to steal your money!!!!

In reality, that "anti-tax" proposition was nothing more than a giant Ponzi scheme.  Since property taxes were capped based on historical cost, it means that the vast bulk of the property taxes are being paid by the newcomers, while the long-time homeowners pay virtually nothing.  It's a rather convenient set-up; not that different from Social Security at its inception, which essentially promised to hand out free money at the expense of future generations.  Except, Prop 13 was a revenue Ponzi scheme rather than an expenditure Ponzi scheme. It worked so long as newcomers were flooding in and home prices were rising. 

The state objective behind the proposition was to prevent people from being taxed out of their homes.  A noble objective, but a flawed execution.  After all, can you really feel all that sad for someone who bought a home in the Silicon Valley in 1978 and saw their property value rise 500%+?  

The result of Prop 13 wasn't lesser taxation.  It was simply different taxation skewed towards a different demographic.  Instead of property taxes, California was forced to rely on a constantly increasing income tax.

In every way, California's budget displays what happens when you combine reckless and irresponsible Democrats with reckless and irresponsible Republicans.  You get idiotic "bi-partisan" compromises like Prop 13.   The end result wasn't lesser taxes; it was merely a tax shift that was based on a foundation that was bound to collapse at some point. 

 

How Much Faith Do You Put in the State of California to Repay Its Debts?

So now that I've rambled on a bit, how much faith do you put in California to pay its debt?  Will it get its act together?  You might think reality forces them to do so and it will ... eventually.  But as I said, Californian politicians don't represent people ... they represent interest groups ---very large and polarized interest groups with specific pet causes.  

How much do you think they are willing to budge?  Their entire foundation is based on enacting policy to suit specific donors.   And this is simply inevitable in a state like California, as Madison might have predicted.  You see --- elections in New Hampshire are local and run on the ground.  Elections in California are run on the airwaves.  New Hampshire politicians are unpaid (with the exception of small stipend to cover expenses) and are still citizens of the communities they serve.  Californian politicians are compensated well and consider their positions in the Capital as a professional career. 

If there's one thing about career politicians, they don't want to be remembered as the ones who both raised taxes and cut expenses.  "Tax and spend" and "spend and spend" are alright.  "Tax and pay back debt" is not very appealing.  So California will probably drag its feet some.  

If you are that contractor, how much faith do you have in seeing your money any time soon?  Do you think you'll see the money in the next 3 months?  How 'bout the next 2 years?  

Even despite the headlines, I'm not sure that the reality has quite set in for these California pols yet.  Maybe they'll hammer out something this week.  Maybe they'll be hanging in a limbo-like state for several years.  Eventually, they'll probably come up with some way to make it appear as if they've balanced the budget when in reality, they are just feeding people more bullcrap.  


California Is In For the Biggest Bust of All

If there's anything that history seems to tell us, it's that most massive booms were followed by massive busts.  the larger the boom, the larger the bust. This is not universally true, but it does seem to hold true most of the time --- large booms are created by unsustainable distortions in the market that will eventually collapse.  

Think about that for a moment --- California has basically been in a 60-year boom cycle!!!  Do you think things will be glowing in Calfornia in another two years?  Another decade?  

I don't want to sound like one of the END OF THE WORLD!!! doom-and-gloomers, but let's just recognize the reality: California is in for a world of pain for a very long time.  The rest of the US may recover ever so slowly from this disaster.  It will take time, but we've emerged from more dismal situations in the past and we can do it again.  Don't expect any miracles, but recovery will come eventually.  The same holds true for California --- just expect it to take a lot longer than the rest of the nation.  

 

What Does California Have Going For It?

From a business perspective, what does California have going for it now?  The tech boom that started in the '90s has fizzled out and California is no longer the capital of technological innovation.   The tax burden in the state is probably going to be enormous for the forseeable future.  And the mirage of the somewhat Utopian lifestyle that California seemed to offer seems to have been destroyed. 

I'm a single male and I'd be willing to move just about anywhere for the right career opportunity.  However, I think I'd want about a 50% premium in salary before I even considered living in California.  The next question becomes, how does the rest of the nation feel?  Will California start losing population or does it still hold enough promise to lure people?  I don't know all the answers, but I'm not betting on the latter at this point. 

26 Comments – Post Your Own

#1) On July 01, 2009 at 9:37 AM, JakilaTheHun (99.93) wrote:

I realize this post was rather disjointed, but hey ... it's a just a blog.  Just shooting out my thoughts as they came to me.  :)

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#2) On July 01, 2009 at 9:47 AM, topsecret09 (37.14) wrote:

The only thing you need to know about Caleeeeeeeefornias demise are two words ILLEGAL IMMIGRATION. I know,I was born and raised In the central valley..... Native born people are fleeing the state In record numbers,but you will not hear It from the FAR LEFT news media out here........ Regards, Jim

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#3) On July 01, 2009 at 9:55 AM, bigpeach (28.49) wrote:

Nice post overall. I will add that while your focus is mainly on the politicians, the voting populace shares as much of the blame. You can blame the politician for irresposibility, but you can't blame him/her for getting reelected, that falls straight on the citizens. Citizens of California (and really the US as a whole) need to take more responsibility for their government.

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#4) On July 01, 2009 at 9:58 AM, Gingerbreadman55 (27.86) wrote:

Personally, If I had a few millions lying around, I would go to California and open up an exchange booth to convert Californian IOU's to dollars with a 5%-10% fee, minimum $20.

 The federal government will back these dumb things, you can bet on that. Think of what would happen if they didn't.

Don't get me wrong, I'm not saying its a good thing, and I know fully well I'm walking into a troubled state and screwing its people even more, but hey, if I thought of this, won't you bet JPMorgan has too?

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#5) On July 01, 2009 at 9:58 AM, Entrepreneur58 (35.91) wrote:

The state that has the fastest crash will be the first to start recovery. 

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#6) On July 01, 2009 at 9:59 AM, Gingerbreadman55 (27.86) wrote:

Not to mention the constitutionality of California issuing money. (which is what those IOU's are, don't kid yourself).

I might as well make a profit off the slaughter of the Constitution.

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#7) On July 01, 2009 at 10:00 AM, RaulChapin (< 20) wrote:

Disjointed or not, it was interesting.

My Brother lived in California, with the LA lifestyle. After being there for 14 years, in November 2008 he just up and left to Guatemala. His reason was that California was too expensive, and while the boom lasted this was justified by the opportunity and the high income, but right now, he rather be paid much less but save some, than risk trying to make it in California and waste his few savings in doing so.

 He was a sales rep, so he had no expectations to ride the wave, no sales, no income... so bye bye LA

 

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#8) On July 01, 2009 at 10:00 AM, ispeedtoo (< 20) wrote:

I do not know OldPhartbsa but he has seen the real California and knows what is Decimated.

OldPhartbsa wrote:
I am the corporate controller for what amounts to thirty two California companies. These companies are engaged in rock mining, concrete production, steel and steel fabrication.

Combined annual sales were as high as $100 million in 2005, but have now shrunk with the economy to roughly $60 million. In 2005 we employed over 500 people, over 95% of them in California. We had over 150 heavy trucks licensed to travel highways hauling steel, rock and sand, cement powder and concrete.

We saw the signs of a recession in late 2006 and began active measures to counter the effects. We were, admittedly, late in mitigating our losses. We had leased to own trucks, quite a number of them, with monthly payments exceeding $200 thousand that would continue into 2010. These trucks had annual vehicle registration fees that ran up to $2,400 each, and federal heavy vehicle use tax of up to $465 each.

We began to mothball trucks, parking them on our facilities and registering them as non-operating, vehicles were put up for sale and purchases have been deferred. We saw fuel costs escalate, particularly diesel, and with that escalation in the base cost of fuel, there was a corresponding increase in State sales taxes. We buy diesel retail, paying sales tax up front, and then apply for a quarterly refund for off-road, boiler and power take-off use. Since 2007, we have had our refund subject to delays of up to nine months.

After laying off as many people as feasible, yet still have a core of specialists capable of maintaining day to day operations, a direct cut in wages was avoided by cutting hours worked. Rather than an eight hour day, my staff now works seven. Some now work eight hours and take alternate Fridays off. There is no pension, but there is a small employer contribution to the 401-k, health/dental insurance is available (but the employee portion had to go up some this year).

Each of the employees understands that we are trying to keep them employed as best we can while we struggle to survive during the downturn. I can guarantee you that passage of the card check or any union election will effectively close the company. (It is privately owned and operated and the owners are pretty definitive about that.)

If we close there would be about 300 people out of work and the state would lose about $110k per month in sales tax revenue (with about another $75 thousand per month in payroll taxes) and multiple communities in California, Arizona and Nevada would see a loss in their tax revenues and increased local unemployment.

There have been no raises, merit or otherwise, in over two years and we've never had anything like the Holidays that state workers and bankers get. Our holidays are New Years Day, Memorial Day, Independence Day, Labor Day Thanksgiving Day (yes we have to work Thanksgiving Friday) and Christmas Day. No overtime is allowed. I try to make the schedule mutually convenient for my employees and allow them to adjust back and forth between days and each other.

The State of California should have done, and needs to do, the same thing.

First, start laying off piles of workers, shrinking the labor to the bare minimum. The term "workers" doesn't mean ONLY teachers or police or prison guards. It means the thousands of administrative and managerial positions that have little to do with day to day functions.

The DMV is overloaded with managers and administrators, social services is overloaded with managers and administrators, there are literally hundreds of state agencies that can be closed or merged. Hours can be cut, but rather than giving the entire state workers three day weekends, one hour a day can be implemented.

Our so-called elected leaders continue to play games with the California taxpayer, making things as inconvenient to the taxpayer as possible in an attempt to prove how desperate the situation "is*".

We're done with the State's games.

We're fed up with paying state workers approximately, and at minimum, 40% more than we make in similar positions.

We're fed up with paying for state worker pensions that we don't have.

We're fed up with providing state workers with paid holidays that we don't have.

We're fed up with our tax money being overpaid to state workers who then use the excess to pay union dues that allow unions to determine the fate of our state and our tax rates.

We're fed up with taxation with misrepresentation.

We're fed up with state politicians that place the interests of state workers above that of taxpayers.

We're fed up with state politicians (and National) that ignore their constituents, more than ignore...they smirk and denounce us as uneducated or ignorant.

Hard, solid cost reductions through out the State are mandated. And every state worker and every California politician needs to have their nose rubbed in it.

* "Is" as defined by Bill Clinton in which "Is" serves a varying quality of fact.

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#9) On July 01, 2009 at 10:11 AM, JakilaTheHun (99.93) wrote:

BigPeach,

I don't disagree with you about the voters deserving the blame in some sense.  However, on a much deeper level, I think you'll find that the same thing will occur with any group of people.  The problem is the system itself.  It creates an environment where polarizing wedge issues are everything and the actual issues that matter move to the backburner until the problems are too big to fix. 

Yeah, you can blame the voters for not seeing through the crap, but what options did they have?  The Democrats and Republicans are embedded by law.   And is it realistic to ever expect different in this scenario?  I'm not sure that it is.  This may just be human nature and the wisest thing might be to create systems that accomodate for it. 

Besides, can voters who work 40-50 hours per week, commute another 10-20 hours, take care of their families, etc., etc., etc. be reasonably expected to stay informed of all the issues for a state as large as California?  This goes back to the question of "is it governable" to begin with.  I'm not sure it is.  New Hampshire voters can be reasonably informed of NH issues because it's a small state.  Can you expect the same from CA voters? 

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#10) On July 01, 2009 at 10:13 AM, farmnut1985 (36.06) wrote:

Is California offering any interest on their IOU's to make up for not being able to pay?  Seems the people they owe money too should get at least an interest rate similar to a municipal bond.  Only seems fair since we get charged penalties or interest when we all pay bills late.  Oh wait, I forgot, we aren't politicians, and therefore can't make or change the rules as we go.

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#11) On July 01, 2009 at 10:23 AM, RaulChapin (< 20) wrote:

How much are these IOUS worth? it is hard to say, they could be discounted assuming California would not go bankrupt and that if it did there would still be some value to be had from ??Bankrupcy Court??

HOWEVER, since the Chrysler bondholders situation, I am not sure how much people would be willing to risk it.

Personally I think a yield of 7% would be a good starter point on these IOUs, they would work as Zero Cupon Bonds and be discounted based on their maturity date. I believe 10 years is a safe time frame to expect California to pay them back. So add a little math to the game and I say anything under 50 cents on the dollar would be a good value. (0.5083 would give a 7% per year yield on 10 years)

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#12) On July 01, 2009 at 10:32 AM, Entrepreneur58 (35.91) wrote:

The first IOUs are already rolling off the printing press....

http://www.couragecampaign.org/page/-/ArnoldBucks_medium.gif

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#13) On July 01, 2009 at 10:35 AM, tonylogan1 (28.15) wrote:

Jackila - hreat opst +1 rec

ispeedtoo - +1 rec on your comment.

Califonia should be broken into at least 2 states, as Nortern CA is practically a different state anyway. That would not solve the problem fully, but it would help.

The bottom line is that if CA gets federal bailout, then you may as well stay in CA, since the whole country is going down. If BO tells CA to "drop dead" as he should (and probably will since CA will vote for him regardless) then states like Texas, Colorado and Oregon are going to see demographic improvements from the "smart enough to leave" CA refugees.

Anyone buying a house in CA right now is beyond dumb. (Unless the place is in a really bad area where you don't actually want to live, but don't mind being a slum lord, as demographics are moving toward more poor people sharing rentals. Aside from interest rates rising (house prices falling), unemployment soaring, you have a bankrupt government that will be doing all inds of things to raise taxes, including, but not limited to instituting an EU style value added tax.

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#14) On July 01, 2009 at 10:47 AM, biotechmgr (34.53) wrote:

Very interesting and a good post. California will provide a leading example and indicator for what will happen to the rest of the nation, so it bears close watch.

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#15) On July 01, 2009 at 11:00 AM, RaulChapin (< 20) wrote:

Damn.. i just thought about it a little longer... we could use some "derivatives" with this. I would sell contracts for with the IOUs as the underlying "security" for $1 million. I would sell them at 90 cents on the dollar.I would buy credit default insurance for $2 million worth.

If California pays soon, i would have paid $110K in interest for having $1 million for a month or so... a big loss. (Plus the cost of insurance and contracts)

If on the other hand, California takes 10 years to pay, I got $1 million for 10 years, interest free.... when the value of the IOUs drops to 50 cents on the dollar, i would buy $2 Million worth of them, cover my $1 million contract. If California pays, I made a free Million, if it does not pay, I made 2 free million.... (Minus the cost of the insurance and contracts)

No wonder derivatives are so popular! (Note that to do this in a non fraudulent way, i would have to be willing to risk the $100K and actually have them, in case California pays soon enough)

 

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#16) On July 01, 2009 at 12:38 PM, jstegma (29.25) wrote:

You nailed it with the wreckless spending and low taxes dynamic causing the problem.  The problem of overspend/undertax is not specific to California, but they just tend to have the problem a bit more often.  They are a bunch of drama queens out there.  

Once BO tells them to drop dead and they finally believe him, the problem will get sorted out.  Either cut spending or raise taxes or a combination of the two.  It isn't exactly rocket science.  They just haven't faced up to reality that those are the choices and that "none of the above - please send a bailout" is not one of them. 

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#17) On July 01, 2009 at 1:06 PM, UKIAHED (35.78) wrote:

Is California offering any interest on their IOU's to make up for not being able to pay?

Yes - interest will be paid.  Last time this happened (1992) the interest rate was 5% (tax free).  The rate this time will be determined this Thursday.

Will they be paid back - yes.  These are registered warrents and (like bonds) will be paid back at some point.

Fun fact - we in California can use these IOUs to pay our Income tax (or business tax)!

For more info, you can check here

 jstegma - They are a bunch of drama queens out there.

 A bit of a generalizaton don't you think?

We’ve been here, done this.  Most of us are actually quite blasé about this.  This is how our system works – we don’t always like it – and maybe someday it will change.  But, I guarantee that California is not closing shop just yet… 

 

 

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#18) On July 01, 2009 at 3:24 PM, Option1307 (29.75) wrote:

Great post Jakila!

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#19) On July 01, 2009 at 5:05 PM, tahoelivevideo (< 20) wrote:

Hasn't California issued IOU's before?  I seem to remember it was during Grey Davis's watch and he was removed from office.

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#20) On July 01, 2009 at 7:05 PM, QualityPicks (48.80) wrote:

The US govt is in the same path as California's, although the US still has some room to maneuver. I though GM was going to go bankrupt about 4 years ago, but it took a while. GM had room to maneuver, but they made the problem bigger by being unwilling to sacrifice.

The US govt has also been unwilling to sacrifice. Problems are being solved by "creative" solutions implemented mainly by the Fed.

I'm also sick and tired that teachers seem to be the main targets of reductions. I really believe it is well known by government officials that people will feel the pain this way, and would accept higher taxes.

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#21) On July 01, 2009 at 10:34 PM, GeneralDemon (< 20) wrote:

Please don't blame Prop 13 for the State's lack of willpower to cut spending. Prior to Prop 13 the State was raising taxes so fast, the retired homeowners were being force to sell. How does that ensure domestic tranquility?

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#22) On July 02, 2009 at 9:53 AM, 2012IsHere (< 20) wrote:

California is in s very bad situation. The cost of livinf in that state is redicualouse. We have Obama untill 2012 so im sure California will get it back together soon enough

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#23) On July 03, 2009 at 11:41 PM, Tastylunch (29.29) wrote:

I agree Jakila

I see no way out of for CA unfortunately unless they get drastic.I'm thankful my family there will be moving in a month.

Kinda sad that a state like North Dakota that gets a lot right can't gte attract talent to save their life, but an inept crapitude like California gets our best and brightest.Don't get me wrong I love CA but this problem isn't exactly new for them...

I do disgaree with your comment abotu CA politcians being corrupt. That's all politicians in my experience. Doesn't matter where they are from.

I wish I could rec comments. your comment #9 matches my thoughts exactly about voters...

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#24) On July 04, 2009 at 12:01 AM, starbucks4ever (97.24) wrote:

A rec. It is ridiculous that they are still allowed to practice this pretended bancruptcy. I would balance their budget in 5 minutes.

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#25) On July 10, 2009 at 12:37 PM, jstegma (29.25) wrote:

I vote for zloj for governor.  

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#26) On July 10, 2009 at 12:50 PM, theHedgehog (< 20) wrote:

At the root of California's problem is that they have no effective constitution.  Yes, I know there's one on paper, but unlike the constitution in your state, it can be changed by referendum, or popular vote.  What this means is that anything with a lot of money supporting it (and there's a LOT of money in California) can become part of the constitution.  It doesn't have to make any sense at all, and it can be overall detrimental to the state's well-being; such as Prop 13.

Another issue is that there is no incentive for the legislature to make a move on the budget.  Sure, the so-called constitution calls for a budget to be completed by July 1, but there are no consequences spelled out if there aren't.  As a result, July 1 is a soft target rather than a deadline.

California also supports too many poor people.  As we can now see, this was only ever possible due to the taxes from the obscene amount of money being made in the state by the entertainment and tech industries.
When that money goes, what do you use to feed and house the poor that you've encouraged to come to from the other 49 states and every impoverished South and Central American country?

It will be interesting to see what rabbit California manages to pull from the hat.  The best one in there would be to get rid of the plebiscite system and do some serious damage to Prop 13.  Is that gonna happen?  Not likely.

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