California: More IOUs?

California is a greater risk than Greece

Excerpts:

Mr Dimon told investors at the Wall Street bank's annual meeting that "there could be contagion" if a state the size of California, the biggest of the United States, had problems making debt repayments. "Greece itself would not be an issue for this company, nor would any other country," said Mr Dimon. "We don't really foresee the European Union coming apart." The senior banker said that JP Morgan Chase and other US rivals are largely immune from the European debt crisis, as the risks have largely been hedged.

California however poses more of a risk, given the state's $20bn (£13.1bn) budget deficit, which Governor Arnold Schwarzenegger is desperately trying to reduce.

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Earlier this week, John Chiang, the state's controller, said that if a workable plan to reduce the deficit and increase cash levels is not reached soon, he will have to return to issuing IOU's, forcing state workers to take additional unpaid leave and potentially freezing spending.

Last summer, California issued $3bn of IOU's to creditors including residents owed tax refunds as a way of staving off a cash crisis.

"I can't write checks without money; that's against the law. My main goal is to keep the state afloat, but I won't be able to do it without the help of new legislation," said Mr Chiang.

Comment: More

Economic Aftershocks in Greece and California

Excerpts:

Greece's economy comprises only 2% of the overall European economy -- about the same magnitude as Indiana's in the United States. Greece's deficit to GDP ratio, while high at about 12.5%, is not that much higher than that of both the US and Japan, around 10.5%. True, Greece has a sizable accumulated debt over many years, estimated at about 110 percent of its GDP, but even the U.S. has a debt to GDP estimated at 94 percent and projected to break 100 percent by 2012. And Greece is embedded within the euro zone which actually has a fairly low deficit to GDP ratio by today's post-collapse standards, only 6%. So there is little doubt that Europe has the capacity to absorb Greece's troubles. This is a matter of investor confidence, not economic fundamentals.

But California by comparison makes up 14% of the US economy, about the same magnitude as Germany's economy in Europe, truly "too big to fail." Yet when California threatened to default on its loan obligations last summer and Governor Arnold Schwarzenegger asked for a federal bailout, the Obama administration flatly rejected it. That caused California to have to issue IOUs as a way to pay its bills, and its bond rating plummeted.

California's situation in some ways is more worrisome than Greece's. Having a state that is one-seventh of the national economy in dire straits is a threat to the nation's economic recovery. It is analogous to having Germany struggling instead of Greece, striking at the heart of Europe. California has been shaken by widespread layoffs and furloughs -- the city of Los Angeles just laid off 1,000 more workers -- and core social programs have been slashed. Millions of low income children have lost access to meal programs, and community clinics have been closed. Almost three million low income adults have lost important benefits such as dental care, psychological services and mammograms.