Rebel Traders – Analysis Without The Hype

The California budget is in a ‘precarious’ condition. Once again California is bleeding money, and there are not enough band aids to control the bleeding.

California Controller John Chiang has stated that the state may have to issue IOUs for the second time in as many years. California has a $20 Billion budget deficit.

“If solutions are slow to emerge and if they are neither credible nor sustainable, California will once again be unable to timely meet all of its payment obligations and my office will be forced to seek costly emergency financing, or conserve cash by delaying payments or issuing IOUs,” Chiang wrote.

The state issued $2.6 billion of the vouchers last year to pay bills, resorting to promissory notes instead of cash for the second time since the Great Depression as Schwarzenegger and the Legislature were deadlocked over how to close an imbalance that totaled $26 billion at the time. The tactic allowed it to preserve cash for the highest-priority bills, including payments to bondholders, until an accord was reached and the state was able to sell debt to generate funds. […] (Bloomberg)

When California issued IOUs last year it created more hardship for small businesses and residents who were already hurting for cash. If California repeats the same IOU program we can expect to see a trickle down effect of more small business failures and an increase in delinquency rates in all forms of credit products, including mortgage payments.

Illinois is technically insolvent…

Illinois appears to meet classic definitions of insolvency: Its liabilities far exceed its assets, and it’s not generating enough cash to pay its bills. Private companies in similar circumstances often shut down or file for bankruptcy protection.

"I would describe bankruptcy as the inability to pay one’s bills," says Jim Nowlan, senior fellow at the University of Illinois’ Institute of Government and Public Affairs. "We’re close to de facto bankruptcy, if not de jure bankruptcy." […]

[…] While Illinois doesn’t have the option of shutting its doors or shedding debts in a bankruptcy reorganization, it seems powerless to avert the practical equivalent. Despite a budget shortfall estimated to be as high as $5.7 billion, state officials haven’t shown the political will to either raise taxes or cut spending sufficiently to close the gap.

As a result, fiscal paralysis is spreading through state government. Unpaid bills to suppliers are piling up. State employees, even legislators, are forced to pay their medical bills upfront because some doctors are tired of waiting to be paid by the state. The University of Illinois, owed $400 million, recently instituted furloughs, and there are fears it may not make payroll in March if the shortfall continues.

Without quick corrective action or a sharp economic upturn, Illinois is headed toward a governmental collapse. At some point, unpaid vendors will stop bidding on state contracts, investors will refuse to buy Illinois bonds and state employees will get paid in scrip, as California did last year.

"The crisis will come when you see state institutions shutting down because they can’t pay their employees," says David Merriman, head of the economics department at the University of Illinois at Chicago.

A record $5.1 billion in state bills was past due at yearend, almost doubling to 92 days from 48 days a year earlier the average amount of time it takes the state to pay vendors such as doctors, hospitals, non-profit service providers and other contractors. (source: Chicago Business)

What happens when state budgets are broke? Only one of two things can happen, cut services and employees or raise taxes. Anyone care to guess which way Illinois will go?

In my own state of New Jersey, Governor Christie takes over the helm from Governor Corzine tomorrow. First order of business will be the budget. New Jersey has serious problems as well and expectations are for deep cuts across the board. But I won’t rule out tax hikes down the road either.

Stay tuned, the budget problems facing the states is just beginning.

Remember last year when California was so cash poor they had to issue IOU’s instead of actual payments. (See December 31, 2008 post “tax refunds in California may be IOU’s”).

Well now it is Déjà vu again.

California is facing yet another cash crunch this year, and on top of that their debt rating was just cut to A- over the deepening budget situation.

Standard & Poor’s on Wednesday cut its rating on California’s $64 billion in general-obligation debt to A-minus from A and warned that the outlook was "negative," meaning another reduction could loom.

S&P cited new concerns about the state’s finances, including a possible cash shortage "if the state’s revenue and spending trajectories continue."

Scrambling to close a $20-billion budget gap, Gov. Arnold Schwarzenegger has proposed a number of one-time fixes — including having the federal government contribute nearly $7 billion in new aid. Yet the state’s chief budget analyst believes the odds of getting that much help from the U.S. are "almost nonexistent."

S&P worries that the state could face a cash crunch in March, before it receives the income tax payments due in April.

"There could be days in March when they go into a negative cash position," said Gabriel Petek, an S&P analyst in San Francisco.

Although Petek said he didn’t believe California would be in jeopardy of missing any payments due on its debt, he said the government might again pay other obligations with IOUs, or the state might again require a short-term loan from Wall Street.(Source: LA Times)

This sounds very similar to the situation one year ago, although this time the credit rating has deteriorated, and so to has the fiscal outlook for California. I sure would hate to be expecting a tax refund in California this year (again).

… Of course CNBC is already known worldwide as the most obnoxious, silly, unprofessional, and absurdly stupid. But in an interview today during CNBC’s ‘Power Lunch’ segment California Attorney Jerry Brown discusses a suit being filed against State Street Bank of willful breach of contract. A breach that was originally brought to the attorney general through a whistle blower system, not by Mr. Brown himself.

Instead, CNBC is more concerned that Mr. Brown is simply using this as some sort of publicity stunt to gain popularity for a possible run at the Governor seat.

The interview that follows (video below) reveals just how stupid CNBC really is. Forget all about the suit against State Street, forget all about how the California pension system may have been screwed by State Street Bank, forget all of that and just ask him if he is running for Governor and is picking on State Street.

CNBC: The world already knows you are stupid (you employ Jim Cramer and Dennis Kneal, need any more examples?), but this interview today reinforces just how terrible your anchors, staff, and production departments really are.

CNBC – First Worldwide In Bull Shit

The good part begins a few minutes in, but it is worth watching the whole of it so you get the full story.

Well if California residents don’t have enough problems already. Now the IOUs that the state government has been issuing as payment will no longer be accepted by major banks starting this Friday.

A group of the biggest U.S. banks said they would stop accepting California’s IOUs on Friday, adding pressure on the state to close its $26.3 billion annual budget gap.

he development is the latest twist in California’s struggle to deal with the effects of the recession. After state leaders failed to agree on budget solutions last week, California began issuing IOUs — or “individual registered warrants” — to hundreds of thousands of creditors. State Controller John Chiang said that without IOUs, California would run out of cash by July’s end.

But now, if California continues to issue the IOUs, creditors will be forced to hold on to them until they mature on Oct. 2, or find other banks to honor them. When the IOUs mature, holders will be paid back directly by the state at an annual 3.75% interest rate. Some banks might also work with creditors to come up with an interim solution, such as extending them a line of credit, said Beth Mills, a California Bankers Association spokeswoman.[...]

The group of banks included Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co., among others. The banks had previously committed to accepting state IOUs as payment. California plans to issue more than $3 billion of IOUs in July.[...] (Source: WSJ)

What a disgrace, fist these super ‘too big to fail’ financial institutions get bailed out with tax payer funds and then turn around and stiff the public.

Now that California is issuing IOU’s as payment Fitch Ratings has cut the credit worthiness to BBB – two notches above ‘junk status’.

Further downgrades are possible, Fitch said, if legislators and Arnold Schwarzenegger, governor, do not end a stalemate over how to close a $26bn budget gap. “This underscores the urgency to solve our entire deficit,” Mr Schwarzenegger said.

By issuing the IOUs for what is considered non-priority payments, including vendor bills and tax refunds, the state is taking steps to ensure debt service on California’s nearly $70bn in general obligations bonds, Douglas Offerman, an analyst at Fitch, said.[...]

The use of IOUs for non-priority payments would offset cash shortfalls into September 2009, as currently projected, Fitch said. But by the end of October the projected cash deficit expands to $16bn, beyond non-priority spending of $10.6bn, excluding tax refunds. The rating, which is four notches below that by Fitch for any other state, is Fitch’s second cut for California in the past few weeks. At the previous single A minus, California already had Fitch’s lowest rating. It is rated at single A level by Moody’s Investors Service and Standard & Poor’s.

Tom Dresslar, spokesman for California state treasurer Bill Lockyer, said: “It is hardly surprising; nevertheless, it is always disappointing, especially for a state that is already at the bottom of the ladder when it comes to credit ratings.”

He added: “The folks who will pay the price are tax-papers when we go to market to sell infrastructure bonds. It will cost taxpayers more money to build their schools, roads, levies, affordable housing.”

California bonds began weakening late in the day. Long-term debt has been yielding just over 6 per cent, about a full percentage point more than other state bonds.[...] (Source: Financial Times)

California is now in crisis mode with little cash on hand. Contractors and individuals who are still waiting for tax refunds will instead an IOU.

Update: The following chart from reuters

With budget negotiators at loggerheads and California government facing a cash crisis, the state controller’s office will start printing IOUs this afternoon for the first time in 17 years.

The presses are set to start at 2 p.m., churning out 28,742 IOUs worth $53.3 million that will be dispatched mostly to residents throughout the state still awaiting their income-tax refunds.

Governor Arnold Schwarzenegger issued a fiscal emergency earlier today and gave the state lawmakers one more chance to reach an agreement on a workable budget. Even if the state is able to reach a budget agreement by midnight tonight it will still mean significant cuts in state services and/or tax increases for California residents.

Failure to reach a budget agreement will result in California having to pay contractors and citizens with IOU’s.

Gov. Arnold Schwarzenegger this morning ordered state workers to take a third day off without pay each month after Republican lawmakers acting with his support blocked a Democratic proposal to ease the state’s deficit and allow the government to keep paying bills.

The Republican governor unveiled billions of dollars in additional proposed cuts to schools and public universities to deal with a deficit that he says is now $26.3 billion, an increase of $2 billion. He also announced an emergency special session of the Legislature that would allow lawmakers to act on them immediately. [...]

[...]If lawmakers and the governor do not agree on a plan to wipe out the deficit — or at least part of it — by the end of today, State Controller John Chiang will begin giving out IOUs in lieu of checks to pay debts owed by the state.

“We have one more day,” Senate President Pro Tem Darrell Steinberg (D-Sacramento) said as his house prepared to convene again.[...]

[...]Thousands of state workers, on whom the governor imposed a third unpaid day off every month, were preparing to show up outside the Capitol today to protest, according to the Service Employees International Union, which represents them. The new furloughs would begin on July 10, the administration said.[...]

[...]Meanwhile, Chiang, who acts as the state’s banker, has scheduled a Thursday morning meeting of a state board that will determine what interest rate the state will pay on the $3 billion a month in IOUs it will begin issuing to contractors and some of California’s neediest citizens, including the elderly, the disabled and the poor.

California last issued IOUs in 1992. Doing so again could have serious repercussions. According to Treasurer Bill Lockyer, the decline in the state’s credit rating that is likely to follow IOUs — as it did 17 years ago — would cost the state $3.4 billion in higher interest rates over 30 years, adjusted for inflation.

Wall Street rating agencies have already warned that they are weighing downgrades to the state’s credit, which would probably take years to recover, Lockyer’s aides said.

So far, no banks have formally committed to honoring the IOUs, said Chiang’s spokeswoman, Hallye Jordan. At least one financial institution, the Golden 1 Credit Union, said Tuesday that it plans to accept the state’s IOUs from its 710,000 members, some of whom are state contractors.[...] (Source: LA Times)

The state of California is teetering on the brink of insolvency. Today the California state Senate failed to approve measures designed to close a massive deficit.

The Senate failed to approve the first of about 20 bills that calls for cutting spending by $11.4 billion through June 2010. The Assembly turned down the bill on a first vote but left open the option to continue voting on it today.

State Controller John Chiang, meanwhile, warned today that he will begin issuing IOU’s next week to local governments, private contractors, state vendors and to taxpayers waiting on tax refunds – unless the Legislature passes a solution quickly.

The bill is part of about 20 bills that make up the package of solutions proposed by Democrats to help close a $24.3 billion deficit.

The votes in both houses failed largely along party lines. Republicans have said they would not support any part of the Democratic plan because, they argued, the proposed cuts were not deep enough and the package includes $2 billion in new taxes.

But today’s votes involved only the bill on spending cuts – not on tax hikes.[...]

Chiang said he will start sending IOUs beginning July 2.

“Next Wednesday we start a fiscal year with a massively unbalanced spending plan and a cash shortfall not seen since the Great Depression,” Chiang said. “The State’s $2.8 billion cash shortage in July grows to $6.5 billion in September, and after that we see a double-digit freefall. Unfortunately, the State’s inability to balance its checkbook will now mean short-changing taxpayers, local governments and small businesses.” (source: SFGATE)

And a breaking news item that came over the wires moments ago:

(US) California state govt plans to tap reserve fund again to meet debt service costs, to file material event notice for bondholders on Thursday

Ouch! A material event notice to bondholders, that won’t go over well.

And one other stab in the back to California today:

S&P places California economic recovery sales tax bonds on credit watch negative

CreditWatch with negative implications following Standard & Poor’’s receipt of information from the state that it intends to make a draw on its reserve coverage account July 1 due to declines in sales tax receipts and a further draw next January. Standard & Poor’’s will review the state’’s economic recovery bond (ERB) ratings after further evaluation of state projections as to the size and timing of potential draws on the ERBs” reserves.

SAN FRANCISCO,  (Reuters) – California, struggling to close a $24.3 billion budget gap, faces the prospect of a “multi-notch” downgrade in its credit rating if the state’s legislature fails to act quickly to produce a budget, Moody’s Investors Service warned on Friday.

The ratings agency’s decision to place California’s general obligation debt on alert for such a dramatic possible downgrade stunned state officials.

“I cannot remember reading a ratings note that raised the specter of a multi-notch downgrade,” said H.D. Palmer, a spokesman for Governor Arnold Schwarzenegger. “It’s another clear warning from the financial markets that there will be substantial and costly consequences if the legislature does not send the governor a budget that he can sign.”

Moody’s in a statement cited California’s expected massive shortfall for fiscal 2010 of more than 20 percent of its general fund budget and limited options for plugging it.

The state’s current A2 credit rating is Moody’s sixth-highest investment grade and makes California the lowest rated of the 50 states. The A2 rating is just five notches above speculative status and Moody’s raised the potential for the rating to tumble toward “junk” status. (emphasis added)

“If the legislature does not take action quickly, the state’s cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July,” Moody’s said in its statement.

“Lack of action could result in a multi-notch downgrade,” Moody’s added.

A downgrade could push California’s borrowing costs up at time when state officials expect to issue up to $9 billion in revenue anticipation notes as soon as possible after a budget agreement is reached — a deal whose timing is in doubt.

Moody’s said California’s leasing debt and other state-related debt are also on review, affecting a total of $72 billion of debt.[...]

Standard & Poor’s on Monday placed California on review for a possible downgrade, also citing concerns about the state’s fiscal stress.

Spreads on California general obligation debt have widened as the budget crisis has worsened. Since May 1, the yield on the five-year California GO scale is up 92 basis points, compared with a rise of 41 basis points for the five-year benchmark Municipal Market Data triple-A scale.[...] Source: Reuters

Today California governor Arnold Schwarzenegger issued an executive order in an attempt to address the serious financial issues facing the state.

EXECUTIVE ORDER S-09-09

by the

Governor of the State of California

WHEREAS due to developments in the worldwide and national financial markets, and continuing weak performance in the California economy, the General Fund deficit for the 2009-2010 fiscal year is estimated to grow to $24.3 billion; and

WHEREAS the State Controller projects that as of July 29, 2009, California will not have the cash needed to meet all of its payment obligations; and

WHEREAS the projected budget deficit will require critical cuts to State programs and services, and additional borrowing from local governments; and

WHEREAS immediate action is needed to address the budget and cash crisis facing the State of California; and

WHEREAS immediate action to reduce current spending must be taken to ensure, to the maximum extent possible, that the essential services of the State are not jeopardized and the public health and safety is preserved; and

WHEREAS State agencies and departments under my direct executive authority must take all available steps to reduce their expenses to achieve budget and cash savings.

NOW, THEREFORE, I, ARNOLD SCHWARZENEGGER, Governor of the State of California, in accordance with the authority vested in me by the Constitution and the statutes of the State of California, do hereby issue the following orders to become effective immediately:

IT IS ORDERED that except for projects funded by the American Recovery and Reinvestment Act, or projects funded by bonds, grants or projects specifically mandated by court orders, or public-private partnerships that require no direct state expenditures, any funds encumbered on or after March 1, 2009, for contracts entered into for which goods or services have not been provided or for contracts proposed to be entered into during the 2008-2009 fiscal year by State agencies and departments, regardless of funding source, are hereby disencumbered and the funds will revert to their original funding source if no legal liability will be incurred by the State.  If a legal liability will be incurred by the State, approval to continue encumbering the funds must be obtained from the Agency Secretary and the Director of the Department of Finance.

IT IS FURTHER ORDERED that by 30 days after the passage of a revised budget for fiscal year 2009-2010, all State departments, regardless of funding source, shall submit a plan to their Agency Secretary that provides for a reduction of the amount of the department’s appropriation to be encumbered by new contracts, extended contracts or purchases from statewide master contracts in the 2009-2010 fiscal year by at least 15 percent, whether the reduction results from cancellation, suspension, renegotiation or otherwise.

IT IS FURTHER ORDERED that effective immediately and until a State department’s plan is approved by the Agency Secretary, a State department is prohibited from entering into any new contracts, amending existing contracts, issuing purchase orders for goods or services, or making purchases from statewide master agreements or leveraged procurement agreements for goods or services.

IT IS FURTHER ORDERED that the Director of the Department of Finance shall establish an exemption process regarding all contract cost reduction measures contained in this Order that Agency Secretaries and Cabinet-level Directors shall utilize to determine if an exemption is justified based on an emergent situation to preserve and protect human life and safety; avoiding significant revenue loss; achieving significant net cost savings; maintaining multi-year IT system and service contracts approved by the Office of the Chief Information Officer; or providing critical services and functions.

IT IS FURTHER ORDERED that the services and functions of state government directly related to the preservation and protection of human life and safety, including but not limited to emergency and disaster response activities and the provision of 24-hour medical care, shall be deemed critical and exempt from this Order.

IT IS FURTHER ORDERED that all Agency Secretaries and Department Directors shall take immediate action to implement this Order to reduce state expenditures.

IT IS REQUESTED that other entities of State government not under my direct executive authority, including the California Public Utilities Commission, the University of California, the California State University, California Community Colleges, the legislative branch (including the Legislative Counsel Bureau), and judicial branch, implement similar or other mitigation measures to achieve budget and cash savings and additional transparency in state government.

This Order is not intended to create, and does not create, any rights or benefits, whether substantive or procedural, or enforceable at law or in equity, against the State of California or its agencies, departments, entities, officers, employees, or any other person.

I FURTHER ORDER that, as soon as hereafter possible, this Order shall be filed in the Office of the Secretary of State and that widespread publicity and notice be given to this Order.