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
Frontier Communicati... 6.79 0.85 14.31%
Windstream Holdings ... 11.83 1.30 12.35%
AT&T Inc 36.59 0.94 2.64%
CenturyLink Inc 39.90 2.19 5.81%
Bank of America Corp... 15.34 -0.16 -1.03%
Data as of 4:03pm ET
Index Last Change % Change
Dow 16,912.11 -70.48 -0.42%
Nasdaq 4,442.70 -2.21 -0.05%
S&P 500 1,969.95 -8.96 -0.45%
Treasuries 2.46 -0.03 -1.16%
Data as of 4:34pm ET
More Galleries
The 13 most WTF gadgets From the weird to the gross, these 13 gadgets will make you wonder why they even exist. More
Best-loved cars in America These cars and trucks topped J.D. Power's APEAL survey, which measures how much owners like their new vehicles. More
America's most powerful cars A new 'horsepower war' has erupted among U.S. automakers and these are the most potent weapons in their arsenals. More
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

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.