California's Debt 6-12X Higher Than Previously Estimated

California Governor Jerry Brown thought he only had a $28 billion 'wall of debt' to deal with, but it turns out it is much larger. From the NY Times:

Directors of the State Budget Crisis Task Force said their researchers had found a lot of other debts that did not turn up in California’s official tally. Much of it involved irrevocable promises to provide pensions to public workers, health care for retirees, the cost of delayed highway maintenance and an estimated $40 billion bill to bring drinking water up to federal standards. 

They also pointed out many of the same unpaid bills from previous years that the governor had brought to light, like $8 billion in delayed payments to schools and community colleges, and $250 million that was raided from a fund dedicated to transportation and treated as revenue. 

The task force estimated that the burden of debt totaled at least $167 billion and as much as $335 billion. Its members warned that the off-the-books debts tended to grow over time, so that even if Mr. Brown should succeed in pushing through his tax increase, gaining an additional $50 billion over the next seven years, the wall of debt would still be there, casting its shadow over the state.

First, $40 billion for drinking water? As a longtime Bay Area resident I've regularly sung the praises of San Francisco's water and had no idea the rest of the state's water was so far off the mark.

Second, it is important to keep figures like California's estimated $335 billion debt in perspective. According to Wikipedia, California has the world's ninth largest economy with a 2010 gross state product (GSP) of $1.9 trillion, or 13% of the United States gross domestic product. Assuming the top end $335 billion debt figure is accurate that works out to only a 17% debt to GDP ratio for the state. Compare that with Japan's and U.S. federal governments's approximately 225% and 100% debt to GDP ratio's, respectively.

Having said that, the significance of these new debt estimates should not be underestimated, particularly when you consider how politically difficult it has been for Brown and the California legislature to address a shortfall which was estimated as a small fraction of the true debt.

Other than the NY Times article, which was cross-published at CNBC, this news is getting zero attention. This is somewhat surprising given that the independent panel includes former Federal Reserve Chairman Paul Volcker. However, I couldn't find anything on either the LA Times or the San Francisco Chronicle's website on this topic.

"Those whom the gods would destroy, they first encourage to borrow cheaply"

Today's must read on the next financial panic.

Podcast: Philip Coggan's Paper Promises - Money, Debt and the New World Order

Below is the podcast of Coggan's book talk, and here is a good review of Paper Promises.

Speaker(s): Philip Coggan

Chair: Professor Christopher Polk

Recorded on 19 January 2012 in Sheikh Zayed Theatre, New Academic Building.

The world is drowning in debt. Greece is on the verge of default. In Britain, the coalition government is pushing through an austerity programme in the face of economic weakness. The US government almost shut down in August because of a dispute over the size of government debt.

Our latest crisis may seem to have started in 2007, with the collapse of the American housing market. But as Philip Coggan shows in this new book, Paper Promises: Money, Debt and the new World Order which he will talk about in this lecture, the crisis is part of an age-old battle between creditors and borrowers. And that battle has been fought over the nature of money. Creditors always want sound money to ensure that they are paid back in full; borrowers want easy money to reduce the burden of repaying their debts. Money was once linked to gold, a commodity in limited supply; now central banks can create it with the click of a computer mouse.

Time and again, this cycle has resulted in financial and economic crises. In the 1930s, countries abandoned the gold standard in the face of the Great Depression. In the 1970s, they abandoned the system of fixed exchange rates and ushered in a period of paper money. The results have been a long series of asset bubbles, from dotcom stocks to housing, and the elevation of the financial sector to economic dominance.

The current crisis not only pits creditors against debtors, but taxpayers against public sector workers, young against old and the western world against Asia. As in the 1930s and 1970s, a new monetary system will emerge; the rules for which will likely be set by the world's rising economic power, China.

Philip Coggan was a Financial Times journalist for over twenty years, including spells as a Lex columnist, personal finance editor and investment editor, and is now the Buttonwood columnist of The Economist. In 2009, he was awarded the title of Senior Financial Journalist in the Harold Wincott awards and was voted Best Communicator at the Business Journalist of the Year Awards. Philip Coggan is the author of the business classic, The Money Machine.

Graphic: European Sovereign Debt Crisis - It's All Connected

This is a BIG graphic. The original NY Times version, which is easier to view, can be found here, with the interactive version here.

(click to enlarge)

Links to Chapters in Michael Lewis' New Book 'Boomerang'

Besides a new preface, which Zerohedge has done a nice job highlighting here, Michael Lewis' new book Boomerang is a collection of his previously written stories about the financial problems of various European countries and one U.S. state (California).

Below are links to each of those stories in the order of their publication. They're all worthwhile and still very relevant.

 1. Wall St. on the Tundra (Iceland)

2. Beware of Greeks Bearing Bonds (Greece)

3. When Irish Eyes Are Crying (Ireland)

4. It’s the Economy, Dummkopf! (Germany)

5. California and Bust (California)

Interactive Global Debt Clock

Courtesy of The Economist

The clock is ticking. Every second, it seems, someone in the world takes on more debt. The idea of a debt clock for an individual nation is familiar to anyone who has been to Times Square in New York, where the American public shortfall is revealed. Our clock shows the global figure for all (or almost all) government debts in dollar terms. 

Does it matter? After all, world governments owe the money to their own citizens, not to the Martians. But the rising total is important for two reasons. First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future. Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments, rather as reality TV show contestants face a public phone vote every week. Fail that vote, as the Greek government did in early 2010, and the country can be plunged into imminent crisis. So the higher the global government debt total, the greater the risk of fiscal crisis, and the bigger the economic impact such crises will have.

h/t zerohedge

Default Myth Busting: Sorry Simon and James, the U.S. is not a Default Virgin

Professor Simon Johnson and James Kwak of The Baseline Scenario have an article at Vanity Fair about the geopolitical importance of credit in late-18th century France, Great Britain, and (especially) the United States. Their article, however, fails to mention an important detail which also happens to contradict their claim that "the (U.S.) federal government would always honor its debt".

The consolidation/conversion of U.S. revolutionary state debt into federal debt, which took place in the early 1790s, and which the authors refer to in the paragraph prior to the above quote, represented a U.S. sovereign default. (For more on this event see Reinhart and Rogoff (click on the U.S. tab) or Sylla, et al, which describes the 'haircut' bondholders received (6% to 4%).)

The notion that the U.S. has never defaulted has unfortunately been repeated often enough that, like the incorrect claim that TARP was "profitable", otherwise well-informed people have come to believe it.

In terms of other U.S. defaults, Reinhart and Rogoff also count Franklin Roosevelt's 1933 prohibition on owning gold and the subsequent devaluation of the U.S. dollar vs. gold as a default.

It's not very surprising to see Vice President Biden promoting the myth that the U.S. has never defaulted (in his case following a visit to the U.S.'s largest creditor, China). Professor Johnson, however, should know better.

Michael Lewis on Bankrupt California

It's Michael Lewis week here at the PolyCapitalist.

His latest in a series of financial disaster pieces he's been penning for Vanity Fair is about his home state of California. The whole article is a must-read (here's a link to the full article) but below are a some of the highlights:

But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. “What all the polls show,” says Paul, “is that people want services and not to pay for them. And that’s exactly what they have now got.” As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly.

On the fiscal nightmare that is the City of San Jose...

The ex-Governator

The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody’s and Standard & Poor’s, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt. 

By 2014, Reed had calculated, a city of a million people, the 10th-largest city in the United States, would be serviced by 1,600 public workers. “There is no way to run a city with that level of staffing,” he said. “You start to ask: What is a city? Why do we bother to live together? But that’s just the start.” The problem was going to grow worse until, as he put it, “you get to one.” A single employee to service the entire city, presumably with a focus on paying pensions. “I don’t know how far out you have to go until you get to one,” said Reed, “but it isn’t all that far.” At that point, if not before, the city would be nothing more than a vehicle to pay the retirement costs of its former workers. The only clear solution was if former city workers up and died, soon. But former city workers were, blessedly, living longer than ever. 

This wasn’t a hypothetical scary situation, said Reed. “It’s a mathematical inevitability.” In spirit it reminded me of Bernard Madoff’s investment business. Anyone who looked at Madoff’s returns and understood them could see he was running a Ponzi scheme; only one person who had understood them both­ered to blow the whistle, and no one listened to him. (See No One Would Listen: A True Financial Thriller, by Harry Markopolos.) 

“How on earth did this happen?” I ask him. 

“I think we’ve suffered from a series of mass delusions,” he says. 

I didn’t completely understand what he meant, and said so. 

“We’re all going to be rich,” he says. “We’re all going to live forever. All the forces in the state are lined up to preserve the status quo. To preserve the delusion. And here—this place—is where the reality hits.” 

...and the bankrupt hell that is the City of Vallejo:

On the way back to the elevators I chat with two of Mayor Reed’s aides. He’d mentioned to me that, as bad as they might think they have it in San Jose, a lot of other American cities have it worse. “I count my blessings when I talk to the mayors of other cities,” he’d said. 

“Which city do you pity most?” I ask just before the elevator doors close.

They laugh and in unison say, “Vallejo!” 

I notice on his shelf a copy of Fortune magazine, with Meredith Whitney on the cover. And as he talked about the bankrupting of Vallejo, I realized that I had heard this story before, or a private-sector version of it. The people who had power in the society, and were charged with saving it from itself, had instead bled the society to death. The problem with police officers and firefighters isn’t a public-sector problem; it isn’t a problem with government; it’s a problem with the entire society. It’s what happened on Wall Street in the run-up to the subprime crisis. It’s a problem of people taking what they can, just because they can, without regard to the larger social consequences. It’s not just a coincidence that the debts of cities and states spun out of control at the same time as the debts of individual Americans. Alone in a dark room with a pile of money, Americans knew exactly what they wanted to do, from the top of the society to the bottom. They’d been conditioned to grab as much as they could, without thinking about the long-term consequences. Afterward, the people on Wall Street would privately bemoan the low morals of the American people who walked away from their subprime loans, and the American people would express outrage at the Wall Street people who paid themselves a fortune to design the bad loans. 

The evolutionary explanation underpinning society's collective behavior:

The road out of Vallejo passes directly through the office of Dr. Peter Whybrow, a British neuroscientist at U.C.L.A. with a theory about American life. He thinks the dysfunction in America’s society is a by-product of America’s success. In academic papers and a popular book, American Mania, Whybrow argues, in effect, that human beings are neurologically ill-designed to be modern Americans. The human brain evolved over hundreds of thousands of years in an environment defined by scarcity. It was not designed, at least originally, for an environment of extreme abundance. “Human beings are wandering around with brains that are fabulously limited,” he says cheerfully. “We’ve got the core of the average lizard.” Wrapped around this reptilian core, he explains, is a mammalian layer (associated with maternal concern and social interaction), and around that is wrapped a third layer, which enables feats of memory and the capacity for abstract thought. “The only problem,” he says, “is our passions are still driven by the lizard core. We are set up to acquire as much as we can of things we perceive as scarce, particularly sex, safety, and food.” Even a person on a diet who sensibly avoids coming face-to-face with a piece of chocolate cake will find it hard to control himself if the chocolate cake somehow finds him. Every pastry chef in America understands this, and now neuroscience does, too. “When faced with abundance, the brain’s ancient reward pathways are difficult to suppress,” says Whybrow. “In that moment the value of eating the chocolate cake exceeds the value of the diet. We cannot think down the road when we are faced with the chocolate cake.”

Lewis concludes on an optimistic note:

When people pile up debts they will find difficult and perhaps even impossible to repay, they are saying several things at once. They are obviously saying that they want more than they can immediately afford. They are saying, less obviously, that their pres­ent wants are so important that, to satisfy them, it is worth some future difficulty. But in making that bargain they are implying that, when the future difficulty arrives, they’ll figure it out. They don’t always do that. But you can never rule out the possibility that they will. As idiotic as optimism can sometimes seem, it has a weird habit of paying off.

For more Michael Lewis, both past and present, simply click on the tag with his name at the bottom of this post.

Review Roundup for Michael Lewis' New Book - Boomerang: Travels in the New Third World

Below are a list of reviews published so far. And here are links to all the chapters in the book, which were previously published in Vanity Fair (except the book's preface on Kyle Bass).

NY Times

Telegraph

Forbes

Washington Post

Amazon customers

AEP on Euro Endgame: "Sorry Deutschland. History has conspired against you, again."

Evans-Pritchard on the Eurozone's Debt Endgame:

The Geithner Plan must be accompanied a monetary blitz, since the fiscal card is largely exhausted and Germany refuses to lower its savings rate to rebalance the EMU system. The only plausible option is for the ECB to let rip with unsterilized bond purchases on a mass scale, with a treaty change in the bank's mandate to target jobs and growth. 

This would weaken the euro, giving a lifeline to southern manufacturers competing with China. It would engineer an inflationary mini-boom in Germany, forcing up relative German costs within EMU. That would be the beginning of a solution, albeit a bad one. 

Sorry Deutschland. History has conspired against you, again. You must sign away €2 trillion, and debauch your central bank, and accept 5pc inflation, or be blamed for Götterdämmerung. It is not fair but that is what monetary union always meant. Didn't they tell you?

Full article here. 

QOTD: Argentina's Central Banker - "Greece should default, and default big"

The above quote is from Mario Blejer, who managed Argentina's central bank following the world's biggest sovereign default.

Also from Blejer:"This debt is unpayable...a small default is worse than a big default and also worse than no default."

More here.