A bailout for California?

Forget about Citigroup, AIG, or General Motors. A Golden State bankruptcy would make them all look like small fry.

By Andrew Leonard

Published June 10, 2009 9:30PM (EDT)

As went Chrysler and will go General Motors, et tu, California?

Stephen Lubben, the bankruptcy expert who has been documenting every twist and turn of the Chrysler and General Motors sagas at Credit Slips, notes today that "several people have asked me whether California might not follow GM into bankruptcy court."

The easy answer to that is "no," since states, unlike cities and counties, can't file under the federal Bankruptcy Code.

But the financial press has also picked up on the issue and noted that California might be forced to default at some point this year if it becomes impossible to continually refinance its outstanding debt.

That would be bad. Very, very bad. True, there is historical precedent for states defaulting on their debts, mostly in the pre-Civil War era. California itself failed to pay the interest on its debt in 1854, but it claimed that the bonds in question had been illegally issued and later refunded them by issuing new bonds.

If California defaulted on its debt today, it would have an enormously difficult time regaining access to debt markets afterward, and, writes Lubben, because of the size of its economy, "it would be very difficult for it continue to fund its daily operations without some access to finance."

So where does that leave us? Megan McArdle declares that "California is completely, totally, irreparably hosed." The editorialists at BreakingViews declaim that the state will have "to cut its spending to what is absolutely necessary" and that "this will remove some of the Hollywood glitz from Californian life for years to come." And Thomas Donlan at Barron's wonders whether California "will throw itself on the mercy of the federal government."

The average Californian is richer than the average American and California has more than its fair share of rich people (who pay the bulk of state and federal taxes). But Schwarzenegger and the dysfunctional legislature are hoping Washington will provide the same kind of deus ex machina rescue that it is providing to big banks. Naturally, they want a better deal than the feds are giving to General Motors and Chrysler, because states don't go bankrupt.

A bailout for California? If the rationale for a GM bailout or a Citigroup bailout is that the company's failure would be too devastating a blow for the larger economy to handle, then doesn't the same reasoning hold true for a possible collapse of California? But how could even the mighty U.S. government afford to prop up an economy as large as California's?

The parameters of this debacle become more mind-boggling the longer you contemplate them. The speed at which the U.S. economy is contracting might be slowing, but just as a bottom comes into sight, California is about to start laying off thousands of state workers and has already put a halt on millions of dollars of state contracts. Talk about your anti-stimulus!

Apologies to readers if How the World Works seems a little obsessed with the California nightmare. But I've got a ringside seat at this evolving train wreck, and as Lubben writes, "It is a situation that bears watching, because if you thought AIG's default would have had serious economic repercussions, California would bring a whole new level of systemic risk."

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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