For the State of California and its counties and cities; tax collections tend to be lumpy during the year due to half of all income, corporate and other taxes being collected in the two months of November and April. Given that the fiscal year starts on July 1st and politicians like to spend money all year long; the State and local municipalities have relied on the sale of short term municipal bonds to tax free money market funds to even out cash flow. The total amount of this borrowing can run as high as $25 billion.

Unfortunately for California, with the sovereign debt crisis in Europe and the default crisis in the U.S.; credit rating agencies are in the process of downgrading 7000 muni bond issuers. California who has the lowest rating on the continent, could receive a junk bond rating. Such a rating would make purchase of California bonds by money funds deemed to be imprudent investments. Consequently, California is being forced to try to borrow money from banks at interest costs that may be 5 to 10 times higher in cost.

Starting around the third week in July, California’s Treasury will begin to run increasingly negative cash balances until larger tax payments arrive in early October. With the State continually cash-strapped; those nice people at JP Morgan Bank and their banker buddies bailed California out with bridge loans of $1.5 billion in 2009 and $6.7 billion in 2010 (See here and here.). At the time, because there was no risk of the State being downgraded to junk levels, the interest cost on the two loans were less than 2%. But loaning money to government today is perceived as a much more risky proposition. Last week, JP Morgan bank loaned $2.25 billion to New Jersey, which has a higher rating than California, at a cost of up to 9% interest. At a low 2% cost of interest, it would take 35 years of compounding before the borrowed money would double. But at 9%, the loan doubles in just 8 years.

To instill confidence in the lenders, California voters elected “Moon Beam” Jerry Brown to replace “Terminator” Arnold Schwarzenegger last year. Brown has always been a complicated figure in California politics. In 1975, Jerry Brown became the youngest Governor in the history of the United States by being elected at age of 37. After taking office; Brown was widely liberal on social issue, but was actually a fiscal conservative that favored a Balanced Budget Amendment. After the passage of Proposition 13 limitations on property tax collections, Brown did such a good job balancing the State’s budget that the initiative’s author, Howard Jarvis, actually made a television commercial supporting Brown for his successful reelection bid in 1978.

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California has the worst bond rating in the nation, hovering just above junk bond status.  A lower bond rating means higher interest rates when selling bonds – and California already spends $10 billion per year in bond principal and interest repayments.

In this, as in many other things, California leads the nation, for better or for worse (repaying the money borrowed for President Obama’s Stimulus will cost every American $280 a month for life).

Some people place a portion of California’s debt problem at the feet of voters who approve nearly every bond initiative, from $3 billion for an embryonic stem cell research bond to $10 billion in debt to build a high-speed rail system.

It’s hard to blame citizens of the Golden State for voting for debt when the most famous Californian, Governor Arnold Schwarzenegger, proclaims bonds “a gift from the future.”  It’s also hard to blame voters for approving bonds when the bond ballot descriptions and arguments are chock full of shaky claims.

Take November 2008’s much promoted High-Speed Rail Initiative, Proposition 1A.  Voters approved it by 52-48 after proponents, such as train manufacturers and unions poured $2.5 million into the effort.  As with almost every bond measure, there was no funded opposition.  The measure’s proponents, big business and labor unions, claimed that the trains would offer time-saving travel “AT A CHEAPER COST!” than air travel or car.  And that, the train would, “give Californians a real alternative to skyrocketing gasoline prices and dependence on foreign oil while reducing greenhouse gases. Building high-speed rail is cheaper than expanding highways and airports to meet California’s population growth.”

Really?  Who checks these claims?
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