History is about to repeat in California as the “state’s cash flood may be receding”:

“It’s familiar: A handful of Californians make a killing on investments, and their tax payments send state revenues soaring. Lawmakers go on a spending spree, without a plan for paying the bills when fortunes turn.

“That was the late 1990s, when the dot-com boom made the state flush, but the gains proved fleeting, and California came perilously close to running out of cash.

“Now, as Gov. Arnold Schwarzenegger prepares a landmark program to expand health care coverage to millions of uninsured residents, economists say the state may not have the funds to pay for it. Although tax receipts rose this year, they say, California is once again on budget quicksand.

“‘I’m at a loss to see how they are going to balance this budget,’ said Stephen Levy, director of the Center for the Continuing Study of the California Economy in Palo Alto. ‘The state got bailed out last time around by a surprise revenue surge. That is unlikely to happen again.’

“The expanded programs in Schwarzenegger’s election-year budget were funded largely by Silicon Valley millionaires — capital gains taxes on people who cashed in Google stock, for example, accounted for nearly $500 million in revenue, several experts said — and by the bubble in the housing market that began to deflate after tax receipts that fueled this year’s spending were tallied.

“‘These surges don’t last forever,’ said Ted Gibson, a former state economist. ‘At some point…that revenue stream will either diminish or completely dry up.’

“The governor Tuesday brushed aside warnings that state coffers could soon start to shrink. Referring to the $37-billion public-works borrowing package voters approved last week, Schwarzenegger said: ‘There will be so much construction activities going on that where the private sector will fall off, the public sector will pick up.’

“‘With our infrastructure bonds, we will again stimulate the economy,’ he said…

“‘We’re going to have a big revenue problem,’ said Christopher Thornberg, a partner at Beacon Economics in Los Angeles. ‘It is going to be a mess and Schwarzenegger in a year is going to wonder why he wanted to be reelected…Sacramento is not going to have the cash to pay for things it wants’…

“In 1965, personal income taxes — one of the most volatile sources of cash for the state — accounted for less than a fifth of the state’s revenues. Now they make up nearly half…

“Schwarzenegger came up with a more dramatic proposal: a cap on state spending that would force Sacramento to sock revenue windfalls away in a rainy-day fund. But after voters rejected his ‘Live Within Our Means Act’ in last year’s special election, the governor changed course, supporting big spending increases for government programs.

“Democrats, too, dropped their call for changes in the tax code as state coffers swelled and more money was on the table — at least temporarily — to fund their policy priorities.

“Now, analysts say, the inaction may come back to haunt the state. The influx of cash ‘we’ve seen in the last couple of years could go in the other direction,’ said Brad Williams, an economist in Hill’s office. ‘It is just a question of when.’”

I am stunned. I should not be, but I am. How can anyone possibly think, “With our infrastructure bonds, we will again stimulate the economy” ? The Arnold sounds like he is bragging that California’s infrastructure is in bad shape. “There will be so much construction activities going on that where the private sector will fall off, the public sector will pick up.”

Perhaps other states should wreck their roads and demolish their hospitals just so they too can be lucky enough to get voters to pass bond issues to stimulate the economy. Dear Arnold, write this down on the blackboard and read it until you understand: Unfunded public sector spending is exactly why this country is in the mess it is in. We have wasted well over half a trillion dollars in Iraq, and exactly what did that stimulus buy us?

If floating bonds will stimulate the economy enough to pay for themselves, why not float a trillion dollars worth of them? If printing presses were the key to prosperity, Zimbabwe could easily be the richest nation in the world.

NCPA

The National Center for Policy Analysis (NCPA) is writing about “California’s Mega-Bonds”:

“Tired of exasperating traffic jams, aging schools, and inadequate affordable housing, Californians have launched a new era of public works construction. California voters agreed Tuesday to finance the program by issuing $37.3 billion in bonds — an amount greater than the annual spending of any other state.

“As a growing federal budget deficit has eroded financial aid for highways and other projects, debates have simmered in recent years in state capitals about how to pay for them.

“Critics say California voters made a mistake:

• The borrowing will top $73 billion once the bonds are paid off with interest in 30 years, thrusting the state deeper into debt just as it is rebounding from the dot-com bust
• That could lead to cuts in funding for social services and other programs, they warn.

“Supporters — most prominently, Gov. Arnold Schwarzenegger — argue:

• The benefits of highway and public transit improvements, better-equipped schools, and reduced threats of flooding will be worth the cost
• That is especially true, they say, in a state predicted to swell by the population of Ohio over the next 10 years.

“The four propositions will spend $19.9 billion on roads and public transit, $10.4 billion on school construction, $4.1 billion on levees and other flood-control projects, and $2.9 billion on affordable housing.”

The California Model

The Boston Herald dove off the deep end by proposing, “California’s $37.3 Billion Public Works Rebuilding Program Could Be Model for Other States”:

“California voters agreed Tuesday to finance the program by issuing $37.3 billion in bonds — an amount greater than the annual spending of any other state.

“‘Voters said they are willing to bear the costs and are unwilling to wait for the feds to get their act together,’ said Everett Ehrlich of the Center for Strategic and International Studies, a Washington think tank. ‘That California would see it in its best interest to go it alone and make such a sizable new investment in its future is in many ways new and different’…

“Allan Zaremberg, president of the California Chamber of Commerce, said passage of the mega bonds will become a catalyst for discussions nationwide about funding infrastructure.

“‘This is a real victory for people who have the economy in mind,’ Zaremberg said. ‘Gridlock costs money. It’s really important to maintain our infrastructure.’”

For starters, voters most assuredly are NOT willing to bear the costs. Did Californians vote to live within their means? No, Californians rejected Proposition 76: The California Live Within Our Means Act. Did Californians vote for any tax hikes? Once again, the answer is no. So where is the money going to come from? Future generations? Spending that pays for itself? A hope and a wing and a prayer? As for this being a “real victory for people,” I would say that Zaremberg’s ideas are downright dangerous.

California may have a model, all right, but that model is the road to ruin and bankruptcy.

Housing

The Desert Sun is writing, “Housing market drag on state until 2008″:

“The downturn in the housing industry will continue to depress the state’s economy for most of next year before stabilizing in 2008, the legislature’s top budget analyst predicted Wednesday.

“Legislative budget analyst Elizabeth Hill forecast that residential construction will fall by 4.4% in 2006 and by an additional 13% in 2007.

“Then the analyst said it should stabilize with about 175,000 permits issued annually through 2012.

“‘I think the real story in terms of California’s economy as well as the nation is what is happening in the real estate industry,’ Hill said.

“She noted that the real estate industry, which includes developers, contractors, real estate brokers, title companies, and financial institutions, make up 15-20% of the state’s private sector economy.

“The slowdown in this industry was the largest single factor in a sharp decline in personal income growth, resulting in a drop in withholding tax payments from over 10% in the first half of 2006 to less than 5% in the third quarter, Hill reported.

“‘California has been hard hit by what has happened in the overall real estate sector,’ she said. ‘That is the main reason we see the softness in California’s economy through 2007 and the rebound in 2008′…

“Overall, Hill projected the state budget would end 2006-07 with a $3 billion reserve, but then run short by about $5 billion in each of the following two years and by $1.2 billion annually through 2012 without cuts, tax or fee increases, or borrowing…

“The current real estate slowdown also could affect state and local governments through what Hill called a ‘more subdued’ growth in property tax revenues.

“The recent real estate boom led to a 35% increase in property tax revenue between 2001-02 and 2006-07 after adjusting for inflation.

“Hill is forecasting that the annual growth in property taxes will drop from 12% in 2006-07 to below 6% in 2009-10, and then rebound modestly.”

The Landing

Once again, we have a prediction that seems to amount to a soft landing. The landing will be anything but soft. In fact, once the downdraft in California gets going, people may be wondering if there will be a landing at all.

During the boom times, no one pays down debt or saves for the future. That is because booms are artificial by nature. We had a boom based on easy money and shrinking credit standards. There is no way to pay down debt, because the boom itself was based on an expansion of debt, not genuine growth and savings. What extra tax revenue did come in was wasted. Now here we are less than one year from the biggest housing boom in history, and California somehow needed to float another $43 billion in bonds.

We produced an enormous housing bubble of unprecedented magnitude. What do we have to show for it? A GDP of 1.6% and sinking fast. It is taking more and more and more credit just to stand still.

Rest assured California is going to need even more bonds in the years to come (if it expects to keep spending money it does not have). The housing bubble has now popped, but the consequences have only begun. The bottom is going to fall out of income and property tax collection. Unemployment is going to soar along with bankruptcies. In a state where one out of 50 working-age adults is a real estate agent, there is bound to be severe problems in a property bust.

Back in December 2005, Tom McClintock writing for ChronWatch wrote about “Arnold and the California Bond Bombshell”:

“Bonds are seductive. They promise immediate gratification, but they conceal a heavy price. They are certainly the most expensive way to finance projects, costing $2 to retire every dollar of debt. Moreover, the state’s borrowing capacity is finite, requiring careful attention to priorities, since debt once issued cannot be rescinded — only repaid. And every dollar borrowed by this generation reduces the ability of the next generation to meet its own needs…

“Gov. Schwarzenegger is now dealing with the result. He must restore the public works built by a generation of giants while discharging a mountain of pointless debt racked up by a generation of spendthrifts. Only by rigorously applying these principles can he hope to do so.”

Arnold has made a stand. He and the voters of California have agreed to float $43 billion in bonds on top of $30 billion or so in existing bonds. In effect, the voters of California seem to think they got something for nothing. But life doesn’t work that way. Given there is no realistic way to pay this debt back, California is headed for bankruptcy. No, don’t expect an announcement tomorrow, or even next year, but the die has been cast.

Regards,
Mike Shedlock ~ “Mish”
November 20, 2006

Michael Shedlock

Mike Shedlock (Mish) is a registered investment advisor representative for SitkaPacific Capital Management. His blog Mish's Global Economic Trend Analysis includes commentary every day of the week. Mike is also a contributing "professor" on Minyanville.

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