Breaking Views

Default is not an option for California

The Golden State's credit and reputation could not handle the bondholder backlash.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Jeff Segal and Martin Hutchinson, breakingviews.com

(breakingviews.com) -- California has to choose a way to erase its $24 billion budget deficit. But unlike recent examples in corporate America, default and bankruptcy can't be on the table. Stiffing state bondholders would only destroy the state's fragile credit and intensify future budget trouble. The Golden State's only real option is to make big cuts now and balance its books.

Like other states, California has to have a balanced budget. It needs to close the gap in its 2009-10 projections by the end of this month. And with tax receipts down 27% from last year, it's set to run out of cash sometime in July.

Some residents have proposed that the state should declare bankruptcy a la General Motors (GMGMQ), allowing it to cut fat more easily. But there's no bankruptcy protection available for states. Chapter 11 is for companies, and the more relevant Chapter 9 is only for municipalities and other sub-state entities.

Of course, states can choose to default. Nine states, or nearly a third of the 28 existing at the time, repudiated their debts in some form during the depression of the 1840s. Aside from a clutch of southern states' defaults stemming from the civil war, it hasn't happened since.

Back then, however, the bondholders were largely canal and bank financiers in London. States could cut them off and still stand a chance of raising new debt locally or in New York.

Today, the majority of California's bonds are domestically owned, many by retail investors -- hardly a constituency it would be advisable to leave high and dry. Moreover, credit markets are global now. California already has the worst bond rating of any state, and a default could make borrowing impossibly expensive, crimping future budgets even more.

Of course, the state may be able to grab federal help to plug at least part of the gap. And it could just use an accounting fiddle to arrive at a balanced budget, as New York did in 1976. Such moves could tide it over the worst, but arguably only serve to push the problem down the line.

California's only real option is simple. It needs to cut its spending down to programs that are absolutely necessary. This will remove some of the Hollywood glitz from Californian life for years to come. But that is far better than the alternative of defaulting. To top of page

Company Price Change % Change
Bank of America Corp... 16.75 0.02 0.12%
Apple Inc 132.54 1.15 0.88%
Hewlett-Packard Co 34.76 0.93 2.75%
AT&T Inc 34.71 -0.36 -1.03%
Microsoft Corp 46.90 0.00 0.00%
Data as of May 22
Index Last Change % Change
Dow 18,232.02 -53.72 -0.29%
Nasdaq 5,089.36 -1.43 -0.03%
S&P 500 2,126.06 -4.76 -0.22%
Treasuries 2.22 0.03 1.37%
Data as of 4:15am ET
More Galleries
Awesome car options for first-time buyers There are lots of good options for millennials shopping for their first car. These models might not be the most popular, but they're worth considering. More
6 surprising things for sale on Taobao Consumers can buy just about anything and get it shipped to their door from Alibaba's Taobao, China's most popular online shopping platform. More
Most notorious recalls ever It's not just automakers that issue massive recalls. From lawn darts to Pokemon balls, plenty of other consumer products have been deemed dangerous, or worse, deadly. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play