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Experts: Tales of state's demise greatly exaggerated

Gov. Jerry Brown released his 2011-12 state budget yesterdaySteve Rhodes/FlickrGov. Jerry Brown, seen here at a 2009 rally, released his 2011-12 state budget yesterday.

It might seem hard to swallow given Gov. Jerry Brown's dour budget pronouncements yesterday, but if the experts are to be believed, there's a case to be made that things here in California could be a whole lot worse.

Let's start with the typical tale of woe: California's $25-plus billion budget deficit has us teetering on the brink of insolvency. Our debt costs more to insure than Kazakhstan's. The end is nigh for municipal bondholders: Time to start stocking up on bottled water and SpaghettiOs.

It's a popular view and one that has led to plenty of controversy among the state's cognoscenti. Gloom-and-doom rhetoric was a staple on the campaign trail last year, even as Gov. Arnold Schwarzenegger, state Treasurer Bill Lockyer and others were pushing the counternarrative to anyone who would listen.

But it seems like quietly, among the academics and investors whose views rarely make mainstream headlines, that this more optimistic narrative has slowly begun to pick up steam.

The prevailing bright-side point looks something like this: Investor perception (and more broadly, public perception) of California's economic woes conflates two different but similar-sounding things – the state's budget and its state of solvency, or its ability to service its debts in the form of bond payments.

Few people would argue that the budget isn't a mess. California's budget is in among the worst shape not only in the West, according to a study that made headlines earlier this month, but also nationwide, according to another study [PDF] by the nonpartisan Pew Center on the States.

Even the New York Times' Paul Krugman made the point last week that Texas – despite being held up by Meg Whitman and others as a shining example of growth through hands-off governance – is now falling into California-esque deficit territory with a $25 billion shortfall of its own.

"People used to say that the future happens first in California, he writes, "but these days what happens in Texas is probably a better omen. And what we’re seeing right now is a future that doesn’t work."

What Schwarzenegger, Lockyer and some Wall Street pundits have been arguing, however, is that no matter how bad the budget deficit is, the state has plenty of money to pay back what it owes.

Lockyer pointedly noted that the state would only default in the event of thermonuclear war – an opinion he reinforced last month with an editorial in the Los Angeles Times, where he argued forcefully that the fatalist rhetoric surrounding the state's fiscal peril is out of step with reality.

"California has never failed to make its bond payments on time and in full, not even during the Depression. And there is no chance we will smudge that pristine record," the editorial reads.

The same sentiment lately has been getting more ink in the financial press, where columnist Brett Arends has urged investors to buy California bonds, despite others making the case that California could easily be the next Greece.

About a year ago in the Wall Street Journal, Arends argued (for at least the third time) that fears of the state's fiscal demise are overblown, especially given the size of its economy.

"California's latest budget shortfall, $20 billion over the next 18 months, looks a lot less intimidating when compared to the $1.9 trillion state economy," he wrote. "So too does the size of the state's general obligation debts: Standard & Poor's says there are $64 billion in Californian general obligation bonds – those backed by the state's tax power – outstanding."

He made a similar case in MarketWatch late last year, arguing that the state's overall economy relative to its debts should put to rest any concerns that California might soon default.

It’s persuasive. You can hear it anywhere. But it’s total hogwash. You might just as well believe that California is inhabited by pixies from the planet Mars, or that the budget problem in Sacramento has been caused by a giant sea monster destroying downtown San Diego.

It’s not just slightly wrong. It’s almost totally wrong.

California’s a basket case? The state has one of the highest living standards in the country, yet over the past 10 years the economy has still grown much faster, per person, than the national average. According to the U.S. Bureau of Economic Analysis, it’s up 15 percent – compared to 8.9 percent for the U.S. overall.

His column goes on to tick off example after example of the state's fiscal health: high living standards, growing economy, a majority of venture capital investment, taxes that, although high, aren't stratospheric, at least by comparison.

If and until thermonuclear war happens, nobody will know who's right, but these arguments are worth thinking about even if you're not an investor. A state's perceived solvency has financial implications (in the form of borrowing costs), but it is also a matter of pride and identity, with the potential to shape the state's political and cultural narratives.

If nothing else, it makes for a slightly less gloomy foil to what is bound to be a painful budget season.



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