Tuesday, August 17, 2010

The Impending California “Bankruptcy”

The State of California taxes its residents and provides services. The legislature which has a Democratic majority can’t quite come up with a two thirds vote needed to raise taxes (two Republicans need to vote with them). And of course since the Governor is a Republican, it’s all his fault. The State is running out of funds; expenses are greater than the incoming taxes.

One thing little noticed, in the last 20 years, because it has been so gradual, is the absurd rise in pay and retirement benefits for public employees. It used to be that you got your experience in the public sector and then moved into the private sector for a pay raise—government jobs used to be a joke.

Presently, we have a State that can’t produce a balanced budget without "creative accounting." The thing to remember is that California is supposed to pay education and bond interest first out of the tax revenues. Then there is this State retirement plan called CALPERS.

CALPERS assets dropped from 260 billion to 180 Billion in a span of one year. At the time, 260 billion was sufficient; dropping to 180 billion ought to set off an alarm somewhere. The implication here is that the State guarantees your retirement even if the investors at CALPERS screw up. These money managers bought boat loads California Nevada and Arizona real estate paper. All we need now is a stock market crash and CALPERS will be sucked down a drain. It is assumed the taxpayers of California will be responsible to make up the shortfall of the CALPERS fund. Profits belong to the retirees, losses belong to the taxpayers. That’s not quite right.

Two questions arise. CALPERS took some horrific losses; are these losses automatically insured by the California taxpayer? If the cities/counties declare bankruptcy, is the State liable for their incurred losses? The answer is no in both cases.

Here is where things could get quite peculiar. Bankruptcy laws don’t cover States. California as a State can’t file for bankruptcy (it doesn’t have to), but every city and county in the State can. Bankruptcy is a tool used by many to avoid paying their debts. Stating matter of factually that the State cannot file for bankruptcy kind of implies that the State is on the hook no matter what, and that is a very wrong assumption.

States can repudiate their debts, it happened in the 1840’s. The real issue is state sovereignty. The concept of bankruptcy revolves around the settlement of debts through the courts. The courts can’t force the State to do anything. The 11th amendment prohibits citizens from suing the State.

California created a retirement fund that guarantees benefits according to the wage earners salary and not on what the fund has available to pay out. These two facts point to the obvious, you can’t have it both ways. That and the 40 billion dollars that the State needs to keep going next year means that California is at the end of its rope. California will run out of money soon.

If the State is short of funds there is no bankruptcy dodge, it can decide who gets paid and when. California doesn’t even have to repudiate the debts; it just doesn’t pay them all. Investors will find out what the implications are, when loaning to a sovereign State. You can’t sue them. Plus if you’re a city in trouble, file BK and give your debts to the State, chuckle, chuckle.

With CALPERS, California will contribute its designated percentage for this year’s wages to the fund. But from there, CALPERS is toast. The State is not obligated to bail them out. So a lot of these 100k retirement plans now have some issues. The item that amuses me, does CALPERS have sovereign immunity just like the State?

Things are getting a little dicey; reality and retirement are on a collision course. It reminds me of the airline pilot who use to email me, he had a future 80K pension and bought a 300K house just before retiring. When his airlines came out of bankruptcy he had a 40K pension and lost the house.

The Great Depression of 2006—seems like a start, and it is 2010 and the show has hardly begun—everyone is dragging their feet, and I don’t blame them. I hate to contemplate what's next.

Karl Denninger has also written some material on this. Here is a link to it.


Ohio Loan Officer said...

I just read, "We are in an engineered economic collapse".

That's what it seems to me-- the governments, Fed, banks, all working together to try to "let us down slow". If it all crashed fast and at once too many powerful people would lose out. This way they have time to arrange their assets so they lose as little as possible at the expense of the average American taxpayer.

I think when this is all over it's going to make the decade long Great Depression of the 1930s seem like nothing in comparison. Look, we're already 4 years into "The Great Depression of 2006".

SPECTRE of Deflation said...

The various defaults, both public and private, will create the deflation I talk about in my various posts. I think your last post had it backwards. We get deflation today which will necessarily create the printing of money in the future that will lead to high/hyper inflation. The debt must be defaulted on or paid off. Which one are you betting on in the near future?

Anonymous said...

Obama will have to bail out CA. in order to get re-elected. He has lost FLA. due to the bungled response to the oil leak.
If he were to lose CA., he would not have enough electoral votes to win again.
Pension issues are covered pretty well at pensiontsunami.com
When you pay teachers an average of $74,430. in CA.(perNEA), and give them pensions of $44,000 to $60,000. at age 55, what do you expect?

Anonymous said...

Public unions have got to go. High paying govmt jobs/pensions have got to go too. The govmt will rescue all of the states that are going bankrupt. More money printing will enable that. They say if you want to get out of the hole you need to stop digging. The govmt won't stop digging until they wipe everything out. There is no way Obama will ever get re-elected either.

I'm in Calif now but soon moving to Nevada. No state income tax and a state govmt that is much more business friendly.

Rob in NS said...

The debt will neither be defaulted or paid off.

The government will just print the money to cover all the bets and the taxpayer will be left footing the bill via inflation. However there is big difference between printing and producing wealth. I have a hard time believing that governments will just stop payouts for entitlements. Unfortunately the only way they can keep from becoming insolvent is by forcing inflation upon us. We get to keep our jobs and our money just ends up buying less.

If the deflationary pressures, which I agree do exist are allowed to creep into broad ecomony, then all these defined benefit retirement plans become even more underfunded. Weimar Germany chose door number 2 on price is right and we know how that turned out. We don't have any choice unless we want to risk another revolution. It could happen anyway.

That, even I will admit, is a simplistic view of the bind our leaders are in at moment. However the public at large doesn't want to be bothered with fixing the problems. They would rather just die the death of a thousand cuts and remain ignorant to what is really going on. I have in past tried to broach this subject when speaking to family and friends only to watch eyes glaze over. Usually conversation veers to something much more palatable along lines of sports or Idol. Some things never change eh! Romans had bread and circuses for everyone. 2000 years later things are pretty much the same.


Jim in San Marcos said...

Hi Ohio Loan Officer

We are getting there. The people back in 1932 had no idea that they were in a depression. History told us when it started. It's no different today. Most people think this is just a recession and things are getting better. Good news sells newspapers.

Jim in San Marcos said...

Hi Spectre of Deflation

I just don't see any debt destruction to justify deflation. Everyone so far has been bailed out by the government.

When a government prints money, it's just a way to tax everyone by way of inflation.

The country is awash in so much money that it pays very little to put it in a bank, you mise well spend it.

Inflation is picking up, the price of gold and silver aren't rising, your buying power is decreasing.

Jim in San Marcos said...

Hi Anon 8:39

It's hard to say if Obama will get re elected. I'm still scratching my head over how Clinton got re elected not to mention why his wife didn't neuter him.

A Federal bail out could be very complex. If the state can't pay the bill and the Federal government jumps in and offers to pay 50% of your claim if you accept it as full payment then you might have some sort of bailout. With a retirement fund like CALPERS, the Fed could put an upper limit on the draw of say 40K per year.

The thing to understand here, there is no court appeal, you can't sue for more. State sovereignty would allow for the pass-through of Fed funds with conditions. Now if the bankruptcy law was change to where the states could qualify to file for BK, we could have a new ball game. Needless to say, don't hold your breath on this one.

Jim in San Marcos said...

Hi Rob

I remember back 4 years ago when I started this blog, my in-laws kind of gave me a wide berth. I was out of the loop as far as they were concerned on real estate.

Just as with you, their eyes still glaze over with the mental thought that he can't be right again.

I think that the thing you and I have failed to realize, is these people have done something that has them a little worried and they don't need someone pointing it out.

If that fishy odor we are smelling is shades of the Wiemar Republic we have a real problem--of course we already knew that. It's kind of like everyone turning on their printer and printing $100 dollar bills--go for it. Your printed money is no different than the Feds!

Take care

Jim in San Marcos said...

Hi Anon 12:11

Be careful of Nevada, they are close to being broke. My wifes relatives rented commercial space to the Nevada DMV (15 year lease) and they walked away after 2 years. The state didn't have the funds so that gave them the right to break the lease. Here is where that state sovereignty comes into play. Kind of neat isn't it. Just walk away, They can't be sued.

I wish you the best of luck finding a job. There has to be a long line.

Take care

Anonymous said...

The injunction was lifted and CA state job furloughs begin in a few days. Workers and unions are opposing it and it will come up in the courts today.

Government is too big. Fed and State. We have too many govmt workers. We need to get rid of most of them because they don't do much for the country anyway (nor does our government). The only solution is to privatize most of what the govmt has erroneously gotten into and achieve small govmt again. How likely is that?

Can you believe a state is in financial turmoil and the workers, in their delirium of unreality, won't compromise and take the cut in income for the good of the state. All they want is the fat, the good times, the benefits, the lazy hours, the pension plans and health care and an easy work schedule. Selfish. Destructive to the overall good. They are quite short sighted.

They want to keep rearranging the deck chairs as the Titanic sinks.

Man can be so intelligent and so... stupid. The great dichotomy.

Tyrone said...

Nothing really surprising here.

California home sales stall in July
Sales statewide last month fell 20% from June and 22% from a year earlier as federal tax credits for buyers expired. Median home prices remained almost flat.

Anonymous said...

anon 2:33

yes. those government employees are basically in treason to the state and the people of california. they don't care about the situation they just want their full paycheck. they don't want to know anything about reality. they are all in during the good times but don't want to have anything to do with the bad times. very very very low responsibility.

government jobs don't produce anything for the nation. no wealth at all. no gdp increase. they all need to come out to the private sector and contribute to the real economy.

but how can that happen when obama and the rest of his socialist cohorts are suppressing the small business owner... the source of jobs for this country. with all the taxes, regulations, etc. the american small business owner is going to lose all incentive. unemployment will continue upwards, government revenues downwards, more deficits, more printing of money, more borrowing, more monetizing the debt and kaboom the s#%t hits the fan.

we have clowns running our government. have had clowns for the last several presidents.

dearieme said...

"I think that the thing you and I have failed to realize, is these people have done something that has them a little worried and they don't need someone pointing it out."

Yes, a couple of years ago I would occasionally mention how unsound a particular defined benefit pension plan was. The pensioners I knew were so upset at the very idea that I stopped mentioning it. It's not as if I could have given them any useful advice anyway.

frakrak said...

I could feel anon 2:33's frustration with the world ... Thinking laterally, could some or most of those government employees, go for reduced hours or job share with the unemployed if the economic situation gets worse?
I hope things will get better, the American tax payer deserves much better ...

Tyrone said...

Here is some interesting information. The part about the loans could be misleading, depending on what people are doing with the money. For example, I have seriously considered taking a loan out from my 401K and buying more physical gold with it, simply as a hedge for that pot of fiat dollars.

401(k) Hardship Withdrawals, Loans SOAR
In the wake of news about a spike in new applications for unemployment benefits comes another potentially troubling sign: A record number of workers made hardship withdrawals from their retirement accounts in the second quarter.

What's more, the number of workers borrowing from their accounts reached a 10-year high, according to a report issued Friday by Fidelity Investments.

Jim in San Marcos said...

Hi Tyrone

Thank you for the links.

I wouldn't go off of the deep end borrowing to buy gold. Buy what other people don't want, not what the crowd is buying.

In my area real estate is still not worth buying to rent, the cash flow isn't there. But there are a lot of areas where 5 percent down can make you a landlord. If you figure that a house is worth 175 ounces of gold, possession is the same as gold ownership--you just have to work a little harder as a landlord.

The disadvantage is that it is taxable, but on the other hand, it's an inflation hedge just like gold.

Jim in San Marcos said...

Hi Frakrak

I think you have to look at it with an enlightened mind. "What's mine is mine and what's 'yours' is up for discussion."

I use the words "enlightened mind" with tongue in cheek. Government employees want every dime they are due and nothing less. The trouble is, 40 years ago they weren't paid much and had little if any training. They are acting stupid now when it is convenient. It's the "I want my full paycheck" mentality. It's not rocket science to figure out that the that the state is broke. Something has to give. And I can guarantee that that it will be the number of people collecting state paychecks.

SPECTRE of Deflation said...

Oh it will definitely be defaulted on or paid off. I don't say this, but rather the M1 Money Multiplier says so as does real GDP and Unemplyment statistics. We are swirling the bowl, and I'm not sure why some folks think it's a carnval ride instead of a death spiral. Click you heels three times Dorothy.

As for printing our way out of this mess, can you name a country/empire that successfully printed when they were 100% fiat? No country/empire has ever lasted more than 40 years once they go 100% fiat. Next year is our 40th year. Good luck with just printing it up, and no one has lost any money.

Rob in NS said...


All the central bank has to do is push print on the photocopier and all the bills are paid. We then can all sit back and say the bar tab is paid but it will be with worthless dollars. I'm under no illusions as to the mess we are in. I just think that powers that be would rather go down inflation road rather than have a painful 1930's style depression. People tend to be less grumpy if they have money in their pockets even if they can't buy anything with it.

The end game is the same, the common folk end up broke, all that is different is the road getting there.

SPECTRE of Deflation said...

Rob, you are talking about a game of monopoly and not how things actually work in the real world. You can't just "hit the print button" when you are 100% fiat and have been for 39 years. It doesn't work like that in the real world unless you want to go Zimbabwe which would slaughter the bankers. Do you honestly believe the bankers will destroy themselves so that printing can go to infinity?

No, money will be dear until debt is discharged one way or the other. High inflation will happen in the future, but not before they buy everything for pennies on the dollar. Why do you think they were made whole while main street swings in the wind?

Rob said...

All the unemployed common folk are still getting a check beit welfare or Unemployment Insurance. As long as that is happening the game will keep being played the way it has been.

As far as the analogy about the game of Monopoly it seems to me that so far governments everywhere are playing by those rules rather than using common sense. What is needed to fix this problem is some tough love and like you say either default or pay off the debt. Hoover did this and look what happened to him. Do you really think the clowns running this circus want to go down in history as being the ones responsible for destroying our way of life. Deflation will immediately destroy the viablity of the suburban/urban lifestyle we have as a society created since WW2. Inflation will likely accomplish the same thing but rather than short brutish dislocation in economy we will be faced with a 20 year death spiral. This will be enough time for all the politicians currently in power to cover their arses and head to the hills with all the money they plundered.

Some things never change when the Western Roman Empire collapse after the Goths entered Rome the last Emperor got to leave town with all his money and retired to his Villa in country. Like I said before history repeats itself. The paradigm shift we are living thru is such a time. They say the Empire of Rome collapsed in 476 A.D. I wonder if people living then knew this at time.

Anonymous said...

No one can say with certainty when the inevitable inflation will begin a significant increase in impact upon us. We could be in deflationary times just for another 6 months or for another 6 years. There are too many dynamics and variables involved to predict anything.

Eventually, soon or later, The Fed and all other global central banks will begin intensive QE (either with a bang or on a slow upward climb of creating more fiat or credit). Those "dollars" will have to someway work their way into the economies of each country... right now that is impossible because banks aren't lending and people don't want to borrow; and more and more businesses are downsizing or going extinct; and more and more people are losing their jobs; and more and more are saving; and more and more boomers are freaking out about retirement and tightening their belts and not spending; and retailers and corporations are going to shrivel up; and so on.

In deflationary times, the dollar is king. You should have as many as you can acquire.

In inflationary times, cash is trash and you better have hard assets.

The majority of the population get screwed and lose in either of those times because they are not prepared.

Our government is our worst enemy (next to ourselves). Who knows what destructive ploys and unintended consequences will manifest out of their coming actions. They'll push us into deflation or inflation and we'll all be taken by surprise even though we intellectually expect both of them.

Amass lots of cash now. Be prepared to turn it into assets when inflation begins its reign (altho you'll lose purchasing power because the intense inflation will sneak up on you). Learn more skills and improve the ones that you have to meet the demands of a population in a crashed out economy.

The above is your only hope.

The Prophet

Jim in San Marcos said...

Hi Rob

I think we are making a mistake here by thinking that the politicians can be blamed for this mess or for that fact can fix it.

I tend to agree with everyone that their solution to the problem is not going to accomplish anything and most probably will make it worse.

If the inflation takes off, like the Wiemar Republic, it is the rich that get ruined, the poor are unaffected.

The thing that bothers me, is the fact that if the middle class is trashed, you have a very good shot at destroying Democracy. The dream of being rich keeps the present order functioning, if everybody is broke, that dream is gone.

Anonymous said...

This was all worrying me and I feared that, if we went into a depression, I would wind up having to sit on a corner with my guitar and a cup and have to play for my dinner.

Here I am working hard to make money, pay off my debts, have some savings and and easier life and get ahead of the game and eventually some day have earned the free time to play my guitar and enjoy music.

Then I realized... whether I'm successful or whether there is a depression and I lose everything... either way I'll be sitting down with my guitar and playing music anyway!

Anonymous said...

Did you hear the story about the king whose daughter was dying and the doctor told him that the only cure was to cover her face with the shirt of a happy man. The king immediately sent all of his trusted aides out into his kingdom to find a happy man. All of them came back unable to find one. Finally his last aide returned and the king said, "You too have failed to find a happy man as well." And the aide exclaimed, "No, your worship, I did find a happy man but the only problem was that he didn't own a shirt!".

Play your guitar now and enjoy your life!

I think the people with "nothing to lose". The people that live out of a back pack. The gypsy that manages to get around and find a place to stay or a meal in exchange for a little work or company, etc. Who owns nothing. The musician on the corner. The guy who lives in a van on the beach and surfs everyday and hangs out with all the beach bunnies. The depression won't hurt any of them because they are not materialistic and they know how to survive. They aren't tied down by anything. Nothing to lose. Talk to them and they'll say, "What depression?".

Go play your guitar!

Jim in San Marcos said...

Hi Prophet

If we look at inflation historically, it usually happens in "not so bad of times." I tend to believe that with everyone saving for the rainy day, the money created by government isn't being spent and the inflation is not present because of that fact.

It's kind of like buying a life boat unseen, without the ability to test it for seaworthiness. Your savings are there, but will they buy anything?

Your quote, "Amass lots of cash now. Be prepared to turn it into assets when inflation begins"--doesn't seem to anticipate the "group think" behavior. Everyone is going to head for the life boats at the same time, so I don't see that working.

Your plan could work, I'm just suggesting that it might not be as easy as you suggest.

Jim in San Marcos said...

Hi Anon 8:08 & 7:56

A good guitar, a bottle of wine, candle light and your love beside you is an image that works well. Omar the tent maker comes to mind --a jug of wine, a loaf of bread . . . . .

But I think if you picture a retired person with savings that are about to be trashed, there is where the tragedy lies. These are the people that will pay the bill. I don't see a happy ending.

Anonymous said...

This is a long article and has links for related articles that are very important... making the read even longer. But... for those who are really interested (especially inflationistas) you need to read this with an open mind. After reading this I can't see how one can argue that we are in or going into inflation. We could be in "contained depression" for another decade. Please read and return to this blog with comments. What inflationary argument can stand up to this?

Jim in San Marcos said...

Hi Anon 11:25

I had to read it twice, I couldn't believe it. If it was an economics term paper, I would have given it an F minus.

To agree or disagree with someone elses beliefs, doesn't give them factual relevance.

Tyrone said...

Your quote, "Amass lots of cash now. Be prepared to turn it into assets when inflation begins"--doesn't seem to anticipate the "group think" behavior. Everyone is going to head for the life boats at the same time, so I don't see that working.

Everyone heading to the "lifeboats" at once is a loss of confidence in paper money. Sounds like hyperinflation.

Here is Exter's Pyramid. Demand collapses downward.

Tyrone said...

Well, what a coincidence. I just read a new post at FOFOA and he wrote...

Credibility Inflation
Hyperinflation, in most people minds, drums up images of trillion dollar Zimbabwe notes. But this image is simply the government's reflexive response to the onset of hyperinflation, which is actually the loss of confidence in the currency. First comes the loss of confidence (hyperinflation), then, and only then, comes the massive printing to keep the government and its obligations afloat.

And what sets the stage for hyperinflation is a period of high credibility inflation followed by the loss of credibility. During our period of high credibility inflation the dollar was invisibly hyperinflated in a near-monetary sense. This has already happened. We are already there.

Great minds think alike?

Anonymous said...

The fact that economists and lay people are engaged in this huge debate as to whether we are in a recession or not, a depression or not, or whether we will have deflation or inflation just shows one thing to me---

everyone is confused, doesn't have enough of a grasp of the laws of economics and doesn't know economic history--thus, doesn't know their ass from their elbow.

I'm not saying I know either. I'm just as uncertain as everyone else is.

Jim in San Marcos said...

Hi Tyrone

Thank you for the links. I'm not sure that we are there yet for hyperinflation as fofoa suggests--that could take years to get there (I hope)

frakrak said...

Yeah Jim, I can imagine a lot of public servants giving up half their entitlements voluntarily :-) but governments can act responsibly thru legislation to lighten the load of the unemployed.

Not sure if I could agree that the U.S. is close to Hyper-inflation, the U.S. dollar is holding up pretty well at the moment, Ben's money printing is defying economic gravity! The guy should be in Vegas performing these miracles before a paying audience, (instead of the paying public).

Thinking he may have a Mayan callendar hanging in his office (no point after 2012)...


Rob said...


You are right. The only thing the government can do is make things worse. When I speak of govenment I really mean the oligarchs that are running things. That is a better catch-all as it includes both the business and political elites.


Anonymous said...

Everyone should understand that Congress and the rest of government has been usurped by big business. The military-industrial complex (buzz word from the 60's) is still alive and well. And doing very well I might add!

We've been the slaves, the feudal serfs, the farmers, the factory workers, the corporate chain employee, and now the consumer chasing "the American dream". All synonymous. Wish I was born into the elite class. At least I'd be the last to do down in flames, and I'd go down in luxury and comfort.

Anonymous said...

Correct. The incredible thing is that these idiots that have put holes in the boat and are sinking it, don't realize that they are on the boat too!

We're all going down. No one will be spared in the long run.

The Prophet

Anonymous said...

Government pensions get an annual cost of living increase. So any retired teacher, city landscaper,etc. will automatically be protected from inflation.
The retiring police chief in San Jose, ca. , age 50, will recieve about $8,000,000. in benefits in his lifetime. see the story at pensiontsunami.com

SPECTRE of Deflation said...

Prophet, great advice on being nimble as this unfolds. There is no one answer to what we will experience, but rather it will come in stages as you suggest.

I keep hearing that hyperinflation will be caused by a lack of confidence in our reserve currency. EVERYONE ELSE IS IN THE SAME DAMN BOAT GUYS. Look around folks, and you will quickly realize that we are all swirling the bowl, but it won't be America going down the bowl first, but rather last. This is/will be worldwide, so you better get your ducks in a row concerning the pecking order of the various countries going down.

How hard is it to understand deflation? If you give me a million bucks, and I stick it under the mattress, the velocity is a big fat goose egg. Not to mention the fact that debt is blowing up all around us, and people are saving/paying down debt at 6% right now, today.