If California defaulted on its bonds could this cause an economic catastrophe?

Question

I work in the state legislature (as a legislative aide) and I'm concerned that this could be a distinct possibility. California's spending has consistently outpaced our revenues. I believe our debt is currently at its highest ever level and we recently borrowed just to meet our day to day expenses (the first time we ever had to do that) Despite a 23 percent increase in revenues in the last three years, we’re running the biggest deficit in California’s history.

This is all happening in a good economy with revenues consistently increasing. What would happen in an economic downturn? If revenues were to decline what would happen then? I believe the debt could eventually be so big that we could no longer pay it, and we could then default. When Argentina defaulted on its bonds, its economy collapsed. But what I'm not clear on is how can defaulting on bonds lead to economic collapse?

Answer 1

That's because the people that make the decisions for california are like, stupid, and stuff, or dishonest, at best they just plain can't add, do percentages, multiply etc. In other words, incompetence any way you look at it. California needs to take the budget axe to a lot of their social programs in order to regain solvency. Their spending ambitions have consistently outpaced their capacity to finance, the property taxes etc are going through the roof, sales tax goes up, up, and up, they're setting themselves up for failure unless they can figure out how to chop about 30% out of their spending and get 'back in black'.

I would've thought that Arnie would be more gung-ho about doing stuff like that, but I guess not...the 'governator' is just another spendthrift figurehead with no public accountability...

Answer 2

It's possible it's the beginning of an economic downturn already. The real estate market is cooling (which is where all those healthy revenues came from in the first place - higher property taxes due to higher home prices)

What happens when you pay for a service and the company you paid can't deliver and goes out of business? Is anyone else going to buy that service from them in the future? Not likely.

Think of the service as more bonds.

Answer 3

Default causes concern in the financial community. And like a turtle, it pulls its head in to protect itself.

However, the turtle becomes an easy target and it's own inaction causes it doom.

The only thing worse that could happen to California is if Hollywood would produce a TV series or movie with the Republicans as heros and Democrats as villians.

Answer 4

Certainly... the whole reason that one would purchase bonds is the confidence that one has in the return on investment. We're supposed to be able to trust (ahem) the government. And just like with the stock market, consumer confidence (or lack thereof) can have far-reaching effects. If no one is willing to risk their money on bonds, then the government has lost a funding source.

Answer 5

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Answer 6

I hear your concerns, but in the case of california, they have an utterly tremendous resource to tap: Property taxes. California alone is worth several hundred times the value of Argentina (in land value), with an economy that trumps all but a handful of first world countries. Argentina and most of south america have notorously unstable both economically and politically.

California in contrast is remarkably stable, on the of the linch pins in the world's most robust and dynamic economies. It also has one of the most diverse economies in the world, with industries that range from agriculture to biotech to computer and entertainment. It has a firm credit rating, has never defaulted on state issued general bonds, or even been late in an interest payments. Its current 'crunch' comes from the fact that it is attempting to keep its taxes low. Would it raise its state income or property taxes significantly, it could raise tremendous capital in a very short period of time.

If ever they approached anything resembling a 'default', they would be forced to raise the taxes to pay their debt before any default occured. The potential tax base california has to draw on is utterly enormous.

Now, speaking hypothetically, and depicting an enormously unlikely serious of events, if California were to default on its bonds (virtually impossible, but for the sake of conversation, lets dicuss it anyway), it would not lead to economic catastrophy. No currency is based on California (unlike Argentina), but instead the full faith and credit of the complete United States. It would dramatically reduce california's bond rating, which would make floating bonds much more difficult and exobinantly expensive....as Cali would have to dramatically increase interest rates to compensate for increased risk to investors.

This would make it difficult (in the short term) for California to operate in any mode of debt, as its ability to borrow would be severely impacted. Thus, California would be forced to operate on a cash only basis, paying for the services it offers immediately from its actual tax revenues. This would have a dramatic impact on those who depend on state tax revenues, like state workers, those on public assistance, most schools, college, and of course, major highways. Most police, fire departments and hospitals are paid from city coffers with grants from the state...but could operate in a slightly reduced capacity on their own revenue. The only issue that could have an impact on the economy in the short term would be transportation...but it would take several years before the infrastructure degraded to the point where it impacted business.

Time is definitely on california's side though as it would have three things going for it though.....the Doctrine of mutual reciprocity, the US Federal Government and the aforementioned income and property tax base. Mutual Reciprocity is a doctrine established by the USSC in the late 1800s, that basically says that the states cannot tax federal income, and the feds cannot tax state. Thus, virtually any bond that Cali floats would be federally TAX FREE. This makes them very attractive to potential investors looking to protect their assets. Second, the US government which has the ability to float California's monetary supply in the case of extreme emergency. Third ..the ability of the state itself to raise huge amounts of cash in a short time with increased income and property tax rates.

If cali 'defaulted', which is itself highly, highly unlikely (they'd raise taxes long before that happened), it has the ability to repair the damage rather quickly by virtue of its fundementally strong, diverse economy, enormous untapped tax base, federally tax free bonds, and the almost undoubted help of the federal government.

Answer 7

Does it have something to do with the then inability to borrow money?

Answer 8

Maybe