Will California Declare Bankruptcy in 2010? Skip to main content

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Will California Declare Bankruptcy in 2010?


Will California become the first US state ever to default on its bonds in 2010? Last year, Governor Arnold Schwarzenegger spent most of the year haggling with the state legislature to try to come up with a balanced budget. In May, they warned they might go bankrupt if federal government help was not forthcoming – the Obama administration declined to help them out and they went back to the drawing board. Last summer, they issued IOUs to some vendors in lieu of checks. As of December 1, the state had almost 84 billion dollars in long term budget debt.

Just last Friday, Schwarzenegger revealed a new state budget that includes an additional 6.9 billion dollars of federal assistance – assistance the federal government has not yet agreed to give. Schwarzenegger claims that if it's not received, the state will respond with already decided-upon spending cuts. Those cuts will come on top of deep slashes California has made in its state budget over the last year: hundreds of thousands of workers have been laid off or forced onto unpaid leave, health care for poor children and the elderly has been gutted. These cuts affect millions of people as the poverty rate across California increases: poverty in Los Angeles is now estimated at 20% of the population.

What's caused this frightening state of affairs? The recession, for one thing. California rode the wave up during the housing boom, with some of the highest housing prices in the nation – it's now suffering the depths as prices fall. In the town of Merced, for example, housing prices have fallen 70%. 25% of homeowners whose houses are 'underwater' – worth less than they owe on the mortgage – live in California. Increased unemployment and decreased revenue lead to lower amounts of taxes – and at 12%, California has one of the highest unemployment rates in the nation.

But California has some problems of its own making too. Ballot initiatives allow the population to vote spending mandates, then leave the legislature to find the money to pay for them. At the same time, one of these mandates requires that 2/3 of the legislature approve any tax increase. Since just over a third of the legislature is filled with Republicans who campaigned on 'no new taxes' promises, this is virtually impossible.

Like many people facing finances spiraling out of control, California's reaction has been: deny, deny, deny. Last spring, voters rejected 5 out of 6 measures to control spending. Republicans blame high waged unions and claim illegal immigrants soak up resources. Democrats point out that there are people paying $600 of taxes per year on property worth millions of dollars, and that corporations, not individuals, have been the biggest beneficiaries of the Proposition 13, the 1978 ballot initiative to keep property taxes low.

So should California declare bankruptcy? Well, no. States aren't afforded the protections individuals receive in bankruptcy, and there are no exemptions. Equally importantly, it's a lot harder for a state to rebuild its credit rating than an individual. If California's bonds get downgraded to junk, its interest rates will soar – leaving even less money to provide services to its population. The people of California are the ones who will suffer.

But what California can learn from bankruptcy is this: states, like people, deserve a fresh start – and sometimes they need it, too. What California should do is convene its first constitutional convention in over a hundred years and draw up new rules. Abolish ballot initiatives that mandate spending. Make it easier to raise taxes. Negotiate with the unions. Then, like anyone coming out of bankruptcy knows, they'll have a fair chance at a healthy financial future.

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