State Fiscal Crisis

A Washington That Can Say No


Will state governments respond to President Obama's proposed freeze on a portion of discretionary spending by learning some fiscal discipline?

At Jon Fleischman's essential Cal politics blog Flash Report, Jason Clemens looks at how the loss of an amiable credit market will force politicians to dismantle the Golden State's bloated, wealth-destroying government:

Along the way lenders begin to notice the accumulation of debt and demand higher interest payments to accommodate them for the added risk. This means even higher interest costs, which means even less resources available for a given set of resources. The spiral is now self reinforcing – more spending leads to more borrowing, which leads to more debt and higher and increasing interest costs, which leads to more borrowing, and the cycle begins anew.

In many ways California has already entered this cycle. For instance, according to the U.S. Census Bureau's annual survey of state government finances, interest costs as a percent of revenues has nearly doubled since 2000. Put differently, nominal interest costs in California have more than doubled from $2.6 billion in 2000 to $5.7 billion in 2008.

Some may argue that California is too big an economy for lenders to worry about risk. Such people would be ignoring the fact that California's debt is already the most risky (lowest bond rating) of any state. Indeed, Standard and Poor recently reduced the state's bond rating once again…

The choice for California is not whether to reform. The choice is whether legislators will enact meaningful reforms in a thoughtful, proactive way, or whether reforms will be imposed on us from the outside, probably in the not-so-distant future.

No Powerball for you.

California's budget in 2009 was $25 billion smaller than its budget in 2008. The state's balanced budget law and supermajority requirement for tax increases do not do a perfect job of producing balanced budgets or reining in taxation, but they are useful in times of economic hardship. (This is in a state that can't even come to terms on a piddling reform like privatizing the lottery.)

Last week Obama responded to Gov. Arnold Schwarzenegger's disgraceful attempt to shake another $6.9 billion out of D.C. with an offer of only $1.5 billion in the budget proposal. There are no new sources to drain. And federal aid to states—including ARRA-related stimulus funds and the $25 billion blown on Medicaid in the budget—provides only limited support for state budgets, because those dollars tend to come committed to particular boondoggles.

States can't print their own money, but the federal government can. So far there is no evidence that cautious bond buyers are willing to say no to U.S. government debt. During his audience with Jake Tapper Sunday, Treasury Secretary Tim Geithner made countless variations on the phrase "Again, remember where we were just a year ago." But when asked about the possibility that Moody's might lower the federal government's bond rating, Geithner said U.S. Treasury notes will remain strong because they were strong a year ago:

Absolutely not. And that will never happen to this country. And again, if you step back and look at what has happened throughout this crisis, when people were most worried about the stability of the world, they still found safety in Treasuries and the dollar. You're still seeing that every time. People are reminded again about the many challenges you see around the world.

Never's a long time, but it must be said that the decline in demand for federal debt is a seeming inevitability that continues not to happen.

The Obama Administration has never seen a hundred billion dollars it didn't want to flush down a low-flow toilet, but the California experience suggests even the threat of reducing aid to states (Schwarzenegger and the California congressional delegation have all vowed to keep fighting for a larger chunk of federal pork) can make states reduce spending, if not to accept a great Californian's truer-than-ever assessment of the role of the state:


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  1. Rewind. The lead should read, “Will the federal government respond to balanced budget requirements in state constitutions by adhering to the same requirements?”

    1. Good Morning reason!

      1. Jesus Christ! Don’t you ever sleep?

        Good morning Suki.

  2. At the CNN link: investors remained skiddish

    Freud says sell.

  3. it must be said that the decline in demand for federal debt is a seeming inevitability that continues not to happen.

    Its my understanding that confidential buyers (I can’t recall the technical term) are taking a larger and larger portion of the Treasury auctions. Since all the usual buyers (China, Japan, the retail bond dealers) have no reason to go confidential, the speculation is rife that this is a cover for the US government to monetize the debt by buying bonds from itself.

    So, I wouldn’t be so sure.

    1. How would that work? Do they print new dollars to buy up the notes? And how do they keep it a secret?

      1. So the rumors I’ve heard are that a large portion of buying is happening out of Caymans accounts (seriously). Of course none of this information is public, so that information would have to either be bullshit or, if true, leaked from within Treasury.

        The Fed could be involved if it were borrowing the money from another central bank (happens all the time).

        On the other hand, the Fed’s extension of money to the major NY banks at essentially negative real rates, is done in a way that almost assures that it is plowed right back into Treasuries – so to that extent, it is a monetization happening in broad daylight by proxy.

        1. Another interesting aspect of all of this is that institutional customers buying large amounts have to purchase through the auction process. If the Fed were purchasing large amounts through the backdoor (so to speak) they could be heavily influencing the final auction rate.

      2. Yes. The Federal Reserve buys them. Algebraically, If A = B, then 100000A = 100000B

        You can damn well bet the first 10 people to get new trillion dollars, let’s call them Goldmansax, will notice, and they’ll buy stuff like stocks with the free money. Eighteen months later, the last 200 million people in line, let’s call them Plebes, will notice it in the form of $4 bread. But the rise in the price of bread will be offset by the stagnant wages for services, so it’s all good. And if it isn’t all good, you’ll just go without a haircut for another 2 months and long hair and natural baldness will come back in style.

    2. That reminds me of something I’ve been meaning to ask you, RC.

      How do public bond markets account for inflation risk? You always hear the claim that inflating the currency is good for debtor govts because it makes the debt easier to pay off. But while that’s in process, aren’t lenders just as likely to be adjusting their interest rates and availability to account for it?

      1. Yes Tim they are. And the interest rates go up accordingly. The fact that T Bill rates are still selling at the lower rate says that people don’t think inflation is a danger yet or that safety of the risk makes the rates worth taking. If times get bad enough, the surety of the return is worth a functionally negative return (i.e. rate of return < the rate of expected inflation) The bonds are fixed rate and function like cash. So, you can always sell them off if you think that inflation is about to go up. Of course, no one will buy them at anything but a discounted rate unless they are equally convinced inflation won’t go up.

        1. If the bonds are sold before the investors notice the inflation problem, then the government makes (pays less) money on the spread.

          Once investors determine inflation is going to be a problem they bid for the bonds accordingly. The interest rate on the bond is somewhat irrelevant. If the government marks a bond with a 5% dividend (damn it, I am forgetting all my bond lingo) and inflation over the life of the bond is expected to be 10%, nobody is buying the bonds at par.

          1. A lot of them are “zero coupon”. Basically they are a contract for the government to pay a set amount at a given date. Their sell price is then set by the expected rate of return plus the expected interest rate. So, lets say you have a zero coupon for $1000 a year from now. The bond will sell for $1000 – the rate of return – the expected rate of return.

            1. I got into bonds in class, not since. I do remember the zero cupon bonds, but doesn’t the government sell them at market, not par, too?

              Not mentioning premium or discount because, other than one or two semesters when I had to know, I could never keep them straight. I do notice that most people on the street tend to get them backwards.

              1. The bond takes on a life of its own after it is sold. The government is going to pay the set amount at the set date. If the inflation rate goes up, the market price of the bond drops and the bond’s holder is screwed.

                1. I understand that. I was just talking about what the government gets for it. Anybody issuing bonds can slap whatever interest rate they like on it but they buyer is setting the purchase price. Just noticed you gave a formula above, not a diagram, so we are really talking the same thing.

                  1. Tim,

                    How well are we helping you? LOL

    3. confidential buyers (I can’t recall the technical term)

      direct bidders?
      They aren’t confidential IIRC
      I would think collusion with a primary dealer would be better cover.

    4. There’s no doubt at all that an unusually high percentage of Treasuries are going to anonymous buyers rather than the usual public auction buyers.

      The rates are set at the auction – if the Treasury can clear the auction at a low rate, that’s what it does. The concern with the anonymous buyers is that they may be allowing the Treasury to clear the auction at an artificially low rate; that without them, the Treasury would have to raise rates to find buyers for all the bonds.

      1. Bingo. It’s like the auctioneer participating in the auction (except that this is a reverse auction).

  4. It is odd that a libertarian would support a “privatization” plan which is essentially nothing more than the government selling off a future revenue stream for immediately profit.

    I guess your “no more stealing from our kids” argument” just went up in the most horrid flames of hypocrisy.

    1. If you’re talking about “lottery privatization” I have to agree.

    2. most horrid flames of hypocrisy

      Most horrid indeed. But under the plan, the buyer would have to kick in a mandated portion to the education budget (higher in fact than the actual portion in 2007, when privatization was last discussed).

      If you want to complain about something, complain that the state should be dissolving monopoly concessions, not licensing them out to favored contractors. The Children would be at least as well disserved by a privately run lottery as by the current one.

      1. The Children would be at least as well disserved by a privately run lottery as by the current one.

        Based on what evidence? You are just replacing one monopoly with another. The new monopoly has to retrain workers, institute a new organization, and generate a profit. In the meantime, some investment bank would take a big fat cut during the privitization deal. Where is all this money going to be made up? Do you have such a deep faith in “markets” that it even applies to government-sponsored monopolists?

        1. Cavanaugh is an Obama voter like you Chad. He just gets paid to write ’bout dat market stuff.

          1. He gets paid in gold, Robin Thicke videos and ground unicorn horn powder. The latter is the legal tender in the Cosmotopia otherwise known as Washington, DC.

            1. tim in LA CA i think

              1. Not no more. He lives in still “gun free” DC.

        2. State governments should dissolve their monopoly lotteries and allow private lotteries to be run by anyone who wants to. Only dumbasses will participate in them anyway so the government shouldn’t even bother investigating all the scam lotteries.

          1. private lotteries usually pay out much higher percentage than Gov lotteries
            If I believed in social engineering by the State I’d create one of those lotteries where your “tickets” can only be bought with interest on savings and pay out nearly all of it just to make the proles save their principal as the only way to play.

    3. Chad,

      Rahm Emmanuel was talking about you the other day. Did you catch the news stories?

  5. the state should be dissolving monopoly concessions

    That’s not what they mean by lottery privatization.

    licensing them out to favored contractors

    that is

    Lottery “privatization” is usually favored where they wouldn’t dream of actually privatizing any real government function.

  6. Yes, Ronald Reagan. What an excellent spokesman for balanced budgets and fiscal restraint.

    1. He was fine. That damn Congress with all the purse strings was the problem.

      1. Drug war. Social security. Market skewing tax credits.

        1. Hey, Colonel Stephen Hawking: CONGRESS. It’s in that Constitution thing, real close to the beginning.

          1. Yeah, damn Congress for constantly overriding his vetoes of all the things Col Angus listed, which he was totally against.

            It was totally Congressnomincs that laid the groundwork for the staggering deficits we run today.

  7. “A Washington That Can Say No”.

    A masochist says “hit me”. A sadist says “no”.

  8. I would like to know why a state would privatize its lottery. How can you NOT make money on a lottery monopoly? I mean, the states don’t have the right to coin or print money, but the right to have a lottery monopoly is pretty good consolation prize.

    Unless, of course, you expect the central government to have a competing lottery soon.

    1. Exactly. The administrative costs of a lottery are pretty small. It is quite literally a license to print money. The odds are set so that you never lose.

    2. I would like to know why a state would privatize its lottery.

      Convert a revenue stream into a lump sum payment for one. States did it with the tobacco master settlement extortion payments

      1. Convert revenue streams into one lump sum payment. When the private sector gets people to sell their annunities into one lump sum payment, they are called preditory lenders. What would you call people who do that with corrupt union owned state legislatures? What comes after preditory?

        1. What would you call people who do that with corrupt union owned state legislatures?


  9. I would like to know why a state would privatize its lottery.

    I’m reminded of a saying about what would happen to the supply of sand if the government was tasked with stewardship of the desert.

    1. That is the only thing they are in charge of that we are not running out of.

  10. Reagan’s primary explanation why gov’t “is the problem” comes right after that statement. The narrator started talking during it but it is important to know why.

    “From time to time we’ve been tempted to believe that society has become too complex to be managed by self rule. That gov’t by an elite group is superior to gov’t for, by, and of the people. Well if no one is capable of governing himself, who has the capacity to govern someone else?”

    1. Who has the capacity to govern someone else? Smart, cosmopolitian, politically active, young people. People who went to the right schools and majored in things like “insert ethnic group here studies”, work in political activist organizations and own I-pads.

      Generation Obama!! That is who!

      1. They are the people they have been waiting for. Too bad they fired their nannies and can’t figure out where cereal and milk come from.

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  12. the decline in demand for federal debt is a seeming inevitability that continues not to happen.

    When some members of congress start making serious noises about delaying payments on the interest due on federal debt, that’s when the stampede to the exits will begin.

    As long as they have a captive audience of taxpayers and aren’t running the printing presses so fast that inflation takes off, federal debt may still seem like a good idea.

    Not being a fool, I don’t own any of that debt …

  13. the above was me … made a snarky post about joe a while back, and forgot to change the autoheading

  14. Oh dear. Ronald Reagan. This won’t come as good news to my libertarian friends who swear up and down that they REALLY AREN’T crypto-corporatists, HONEST.

  15. Hey Squirrel!!! something called tubemogul is hanging the site real bad
    it wasn’t on my block list but it is now

      1. It’s like a gay Two Guys One Hole.

        1. Hey, you asked.

          First rule of Teh Intertubes — if you can’t handle candor, don’t ask.

          1. I had no objection on getting an answer no matter how peutrid. That was nothing like the bad I was expecting.

          2. I thought the First rule of Teh Intertubes was rule 34. Is for me anyway. The rest is gravy.

  16. Reagan was about small government like Obama is about hope and change. He supported the dramatic increase in the war on drugs. He supported the dramatic increase in military spending. He supported rebel terrorists in Nicaragua, and government terrorists in many more third-world countries. Ed Meese anyone?

    I’m getting frustrated at Reason folks who pretend Ronald Reagan supported small government.

    1. He supported rebel terrorists in Nicaragua

      You mean the Countras, as in COunter to the Communists, right? We really would not want to confuse the reader with your true position now would we?

      You have an objection to countering Marxism for some, at least general, reason, I suppose. If you even know that is what your true position is.

      So why don’t you tell us Comrade?

      1. Wow. So, if I oppose terrorism as a means to fight communism, I must be a communist? That’s brilliant.

        So your true position is that terrorism is okay if it’s in opposition to communism?

    2. Thart awful dramatic increase in military spending brought the Soviets to their knees. Awful huh?

      1. That’s no different than hearing a leftist praise Castro’s literacy program. It’s a half-lie, wrapped in propaganda, in the service of authoritarianism.

    3. War in drugs, bad about the drugs part, agreed.

      Defunding you little Commie friends part? All good.

      1. Let me just repeat that assuming that someone who opposes terrorism as a means to fight the enemy must be the enemy is really, really stupid.

        It’s what Hamas assumes about Palestinians who oppose terror attacks. Nice company you’re keeping there, John.

    4. You left out bitching about Pinochet and tossing bile at The Chicago School.

      1. So, when does the whole economic system go into a black hole with people sleeping in their cars (outside fo Atlanta), looting in the streets and Polar Bears keeling over from foreclosure notices and AGW?

    5. Reagan didn’t do a good job of supporting small government, but he did a great job of talking about it. So as long as we try to forget he was a head of state that presided over a large increase in the size of government and just treat him as an editorial columnist I don’t see any problem with sticking his speeches back up here.

  17. Well Tim, after much deep contemplation and a couple of drinks, I’ve concluded that Washington should just say yes.

    The next state that comes hat-in-hand for a bailout, should get it. The deal is, the Fed forth-with (henceforth?) (hither-yond?) owns said state, chops all its assets into manageable sized pieces, and auctions them off to the highest bidders.

    Original government of said state is summarily disbanded. New state government is formed, where new rules (see below) are hard wired into its constitution.

    Proceeds of selling off state assets are used to first pay off state’s debt*, then the federal debt.

    *In the event the CBO determines a state owes more than it’s assets are frickin worth at auction, the Fed summarily sells all state government employees (elected officials first) of said state into slavery, then auctions off the state assets.

    If this still fails to get the state out of hock, then the state government employees plus their entire families are sold into slavery. As many succeeding generations are sold into slavery as necessary, to finally balance the books.

    A couple of drinks has convinced me that if we just get draconian enough, we could actually motivate our elected officials and our permanent government bureaucracy personnel to make damn sure they don’t over spend their allowance.

    We just need to reinstate slavery the way it used to exist in ancient times. The kind where you can buy your way out, or even sell yourself into servitude if you wish. Except for government employees sold into bondage, the debt they carry is so big that they can never hope to buy their asses out again.

    If this ever happens once, it triggers a new clause with the Fed, which allows the Fed to periodically inspect the financial condition of each state. The moment the CBO determines that a state’s net assets are not at least 10% greater than its debts, then the Fed is allowed to take over and proceed with the auction as per above.

    Now, if we can just figure out how to make a similar deal work at the federal level, we’ll be all set. But I’ll need another couple of drinks before I get that part worked out.

    1. Sign me up.

      The only hitch I can see is that you’re unlikely to get much for your tax parasite slaves. Seriously, how much work can you get out of a politician or someone who’s spent their career as a tenured SEIU member?

      1. 🙁

        Good point RC.

        But it still might be worth doing, just to create the proper incentive structure.

    2. No planter with any sense would give you a plug nickel for a state employee.

  18. Tim and Russ,

    States can print money. Cities do it already. Ithaca, NY, for example.

    1. Hey, I grew up there once upon a time and I didn’t know. Tell me about this printing money thing they did.

  19. Sadly, Obama hasnt realized yet that the actual people that make things happen have all been bought and paid for! Its the American way!


  20. The day politicians dismantle the Golden State’s bloated, wealth-destroying government is the day I rent a truck and move back there.

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