California Debt Is Downgraded: Schwarzies Prepare For A Comeback!

TILB is so incredibly thankful that - as we informed our readers over and over again last spring and summer (click here for all TILB posts referencing Schwarzies) - California has not at all fixed its budget woes. It has another $20 billion deficit expected in the coming 18 months.

It seems as if California lawmakers think this problem might solve itself. That somehow, they are going to miraculously bring in another $14 billion in tax "revenue" - annually mind you - over any reasonably near term period.

Spoiler Alert: Ain't gonna happen. In fact, the more you raise taxes when you are already a high tax regime like California, in the long run, the less tax "revenue" the state can expect to receive. It will actually worsen its problem by driving out marginal growth and productive investment.

The obvious solution is not to try to raise another $14 billion per year - it's to cut $14 billion more in spending per year. Free that capital up so that your citizenry can productively deploy it rather than having a bunch of proven morons in Sacramento deploy it destructively.

As we promised back in July 2009, TILB stands ready to laugh in California's face as their legislature acts like a political set of keystone cops.

Below and linked here is a Reuters article discussing the S&P downgrade [emphasis added and comments in brackets are TILB's].

UPDATE 4-California debt rating cut as cash crunch looms
8:03pm EST* S&P sees budget solution possibly crimping economy

* $19 bln shortfall tougher to close than last year's-S&P [no shit - you can't cut the fat you already cut, so it's all new fat here]

* Cash crunches seen in March, July, but RANs to be paid (Recasts, adds debt insurance costs and comparison)

By Jim Christie and Peter Henderson

SAN FRANCISCO, Jan 13 (Reuters) - California's main debt rating was cut on Wednesday by Standard & Poor's, which said the government of the most populous U.S. state could nearly run out of cash in March -- and another rating cut might follow.

The state government's budget gap of nearly $20 billion over the next year and a half leaves it in a precarious situation, requiring tax increases or spending cuts, either of which may slow economic recovery, the agency said in a statement.

"If economic or revenue trends substantially falter, we could lower the state rating during the next six to 12 months," S&P said after cutting the rating on $63.9 billion of California's general obligation debt one notch to A- from A.

The new level is four notches above "junk" status, a level at which many investors refuse to buy debt.

"The big question is, is there any fear they will get downgraded out of investment grade (so) you may have to sell ... that's where I think it would get interesting or hairy," said Eaton Vance portfolio manager Evan Rourke.

Bond prices did not move much, though, since many expected the downgrade, he said.

S&P's downgrade was overdue because the state's revenues have been so weak, said Dick Larkin, director of credit analysis at Herbert J. Sims Co Inc in Iselin, New Jersey. "Frankly I can't understood why it took S&P so long," he said. "They could have made that decision back in September." [September? Try March.]

$1 BILLION SHORT IN MARCH

California already had the lowest debt rating of any U.S. state before the downgrade, and 39 state governments are struggling with shortfalls this fiscal year, according to the nonpartisan Center on Budget and Policy Priorities.

Many are begging for more federal funds and caught between cutting social programs, raising taxes, or both.

The housing market implosion was felt especially strongly in California, a subprime mortgage lending center. Its double-digit unemployment rate, one of the highest in the United States, is expected to endure for a year or more.

California's government resorted to issuing IOUs last year for the second time since the Great Depression when it nearly ran out of cash. Officials are scrambling to raise $1 billion for March and the shortfall could be worse in July, S&P said. [sounds like Schwarzies are coming back; we're almost giddy with excitement!]

State Treasurer Bill Lockyer's spokesman Tom Dresslar said S&P's downgrade "highlights the critical need for the legislature and the governor to produce a swift budget resolution that is credible to the market."

"Standard & Poor's makes it clear the failure to act in a timely manner and with credibility threatens to further lower our GO rating," Dresslar said, adding that a further cut would hit taxpayers already paying higher interest rates than people in some emerging economies.

The cost to insure California's debt with credit default swaps is now higher than debt of developing countries, such as Kazakhstan, Lebanon and Uruguay. It costs $277,000 per year for five years to insure $10 million in California debt, compared with $172,000 for Kazakh debt. [phenomenal]

George Strickland, a municipal bond mutual fund manager at Thornburg Investment Management said S&P still has California GOs rated too high. Moody's Investors Service has a Baa1 rating on the debt and Fitch Ratings rates the bonds BBB.

"There's another notch to go before they hit bottom," Strickland said, adding that he expects another long and ugly battle to fill the state budget's shortfall.

Governor Arnold Schwarzenegger less than a week ago unveiled a plan to balance the state's books, largely with spending cuts that he described as draconian and which leaders of the Democrat-controlled legislature sharply criticized. [I can't wait to see the Donkey-proposed alternative - Lord willing it involves more unconstitutional minting of Schwarzies by Sacramento]

S&P said "timely progress" on a budget fix would be impeded by previous reliance on one-time measures, fewer choices for one-time cuts, extraordinary reliance on federal aid in Schwarzenegger's plan, and California's unusual requirement for a supermajority of lawmakers to pass a budget.

The Republican governor's budget plan also said that while the state government faces cash challenges in March, it will have sufficient cash to repay $8.8 billion in revenue anticipation debt in May and June as scheduled. [whether true or not, what else can they say? Any other statement would be a hand delivered invitation for the ratings agencies to slash the G.O. rating further]

State Finance Director Ana Matosantos along with Lockyer and State Controller John Chiang said on Monday they are working together so the state government honors its RAN debt.

Bond payments are by law a top state priority and state Finance Department spokesman H.D. Palmer said they will be honored: "Even though we've got to make some decisions in managing March we absolutely have ample cash on hand to make our RAN payments in May and June on time and in full."

Larkin said the three major rating agencies will hold off on more downgrades to California's credit rating to avoid roiling the municipal debt market, even in the event budget talks between Schwarzenegger and lawmakers drag on.

"They'll give the state an awful lot of rope," Larkin said. "For a state to go below investment grade would cast a pall on every state and local issuer out there." [at least market participants publicly acknowledge that the ratings agencies are pussies]
(Reporting by Jim Christie, Peter Henderson, Karen Brettell and Joan Gralla; Editing by Andrew Hay, Gary Hill)

WSJ Acknowledges California IOUs As A Currency; Schwarzies Take A Place On The Podium Next To Clamshells

As California announces a budget that gets them out of crisis...for nine months...it is likely that Schwarzie issuance will soon take a temporary respite (TILB already predicted that this budget will not hold for a variety of reasons).

It is at this juncture in history that the WSJ has decided to reflect on the implications of Schwarzies. The article even goes so far as to employ an uncited use of our phrase "Schwarzenegger Scrip" (we challenge you to find a similar reference older than ours to said currency). The Journal talks about where Schwarzies stand amongst the various scrips that were issued by state and local municipalities during the Great Depression, including certain places that issued clam shells with hand written denominations (if only TILB could have been there reporting...).

Ironically, clam shell currencies held their real value much better than our shitty fiat dollars (lovingly referred to by TILB as "Bernankes"). Per the WSJ:

Two towns in California -- Crescent City and Pismo beach -- circulated scrip printed on clamshells. [The] 10-cent note was issued by the Crescent City Chamber of Commerce. It's worth about $500 today.

And do you know why it held its value (obviously a 5000 bagger is better than "holding its value", even adjusted for dollar debasement/inflation)? Two related reasons explain the return: 1) novelty, which we do not hope for modern currencies to replicate; and 2) scarcity. Sadly, Comrades Obama, Bernanke and Geithner do not seem to fully appreciate the latter reason (or, perhaps more accurate and frightening, they do understand). Rather than talking about holding the volume of dollars somewhat stable, they speak of dropping freshly minted dollars on the populous from the cargo bed of helicopters.

Gold, a currency that has been accepted throughout time fairly universally, allows natural supply/demand forces to function as its central bank. In essence, gold has a built in scarcity function - finding, mining, refining, certifying, and establishing a reputable "brand" are expensive. As such, these functions (which increase gold supply) occur in modest, fairly stable amounts over time, leading to a dependably scarce, value protecting, and widely accepted currency.

The article goes on to inform us that California State Controller Chiang may continue to issue a few more Schwarzies as the implications of the budget are digested:

Since California ran out of cash early this month, it has issued more than 194,000 IOUs, with a total value of $1.03 billion. They are redeemable in U.S. dollars on Oct. 2, or sooner if the state comes up with the money. The legislature on Friday approved a plan to close a $24 billion budget gap, but officials say it could still take a few weeks to analyze the state's cash situation and resume giving creditors checks instead of promises.

Prediction: the state will not come up with the money sooner than Oct. 2nd. Paying them off early would be a negative arbitrage and thus they'd never do it.

If they had half a brain and a good sense of humor, they'd finance old Schwarzies with new Schwarzies and really establish them in circulation.

Stand For California: Arnold Schwarzenegger The Road Stops Here

As LB said in an email to me earlier today, "The unintentional comedy of this is very high."

Indeed.

While Schwarzie issuance continues unabated and the likelihood of the federal government being forced to show its hand vis a vie letting state finances collapse, Arnold has this inspiring and soul affirming video to share with his citizenry.

Good news Californians, "the road stops here." Lord willing, Arnold.

Schwarzie Bids Are Flying! California IOUs Begin To Take Hold As A Currency

Last Friday TILB said it was prepared to fulfill all offers of Schwarzies at 80 cents on the dollar. As an existing Bank of America customer (we know, we know), we were eligible to exchange Schwarzies for Bernankes at par. We have been promoting the notion that as the decisions of banks go, the success or failure of Schwarzies goes.

As the bloggers over at Directive 10-289 (perhaps the best named blog in the entire blogosphere) have highlighted, the WSJ is reporting that "big banks don't want California IOUs".

A group of the biggest U.S. banks said they would stop accepting California's IOUs on Friday, adding pressure on the state to close its $26.3 billion annual budget gap.

...

Amid the budget deadlock, Fitch Ratings on Monday dropped California's bond rating to BBB, down from A minus, the latest in a series of ratings downgrades for the state.

The group of banks included Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co., among others. The banks had previously committed to accepting state IOUs as payment. California plans to issue more than $3 billion of IOUs in July.

...

Wells Fargo's head of community banking, Lisa Stevens, said: "We're very disappointed, as are many Californians, that California has taken the unfortunate step of issuing IOUs in lieu of payments to some businesses and individuals."

State officials said they were disappointed by the banks' decision. Garin Casaleggio, a spokesman for Mr. Chiang, said: "We don't want anybody to suffer who can't redeem them when they need cash."

We are shocked, shocked that California banks, already choking on legions of souring loans, do not want to take billions upon billions of dollars of California's newly issued Schwarzies backed by the state's recently downgraded triple B (with negative watch!) credit risk in return for 3.75% interest. I mean, they already happily take Bernankes offering nil interest no questions asked!

These unpatriotic bastard bankers apparently forgot that as TARP recipients and permanent beneficiaries of government subsidies via the Federal Reserve system and under priced FDIC insurance they are not in charge of making lending decisions, The Administration makes those decisions now. Resistance is futile.

With big banks walking from the Schwarzie market, we hereby lower our bid to 60 cents on the dollar.

It should be noted that states are legally prohibited from filing bankruptcy. We are not sure what the alternative is, but it sure feels a helluva lot like the Feds will have to step in with a guarantee at some point. TILB is sure that somehow Steve Ratner will end up being governor.

In any case, a marketplace for Schwarzies is beginning to take hold. While we believe TILB was one of the first, if not the first, mass bidder for Schwarzies in the country, others have begun to follow suit.

For example, this posting on Craigslist appears to be the Schwarzie equivalent of Cash4Gold (need money fast?!?!) whereas Dealbreaker reports of folks setting up unofficial Schwarzie bidding exchanges.

While optimists may say that each and every day Controller Chiang is improving the Schwarzie system by printing additional liquidity, TILB takes the view that every new batch of minting both adds Schwarzie selling pressure and devalues existing Schwarzies (not unlike our worries about Bernankes). For those that hope our sixty cent bid will improve, do not hold your breath.

I suppose we could leave it unsaid, but we at TILB could not be more pleased with this progression...

California IOUs Have Arrived: TILB's Schwarzie Bid Is 80 Cents On The Dollar

TILB stands prepared to take out any Schwarzie holder at 80 cents on the dollar. Contact us at investmentlb@gmail.com if you have some for sale and you are prepared hit our 80 cent bid. Price is non-negotiable.

Today is a day that will live...in infamy. The Governator and Controller Chiang issued 28,742 "registered warrants", better known as Schwarzies, in TILB parlance. We believe this is the camel's nose under the state issued currency tent and we could hardly be more excited. In a strange sense, the worse California's fiscal situation is, the more likely Schwarzies are to be successful which means the more likely they are to be imitated by other states. Ideally, this will undermine the entire fiat currency system and lead us back to better days.

Amazingly, Schwarzies have received very little in the way of national press during the lead up to their issuance. But tomorrow morning, the front page of The New York Times will have Arnold's stern mug under the headline "Short of Cash, California Will Start Paying With I.O.U.s". The article alludes to the fact that the state will basically issue $2-3 billion of Schwarzies per month until a manageable budget is passed ($4.8 billion by the end of August). This will all be tacked onto the already massive $24 billion budget deficit.

Here are several highlights from the NY Times article:

So California is now just like a family that spends more than it takes in and holds off on the cable bill while paying the mortgage: its expenses are greater than its revenues. The state, which previously used i.o.u.’s in 1992 and 1933, will issue them rather than checks to those it can get away with not immediately paying.

Most warrants will go to Californians waiting for tax refunds, vendors doing business with the state and local governments, especially in social service areas. Federal and state laws prohibit i.o.u.’s from being issued to state employees, schools or Medicaid recipients.

While it is against federal law for a state to declare bankruptcy, California’s move Thursday will not go unnoticed by Wall Street or escape consequences.

The state’s credit rating is already shaky, and any further downgrades from rating agencies could send interest rates on its bonds soaring, forcing deeper service cuts.

Furthermore, if California comes up short on cash this fall, other creditors will have to wait behind the warrant holders, who would most likely end up in superior credit positions.

...

“In evaluating potential registered warrant acceptance, banks have been advised by regulatory authorities to consider such issues as credit quality, capital requirements and concentration limits,” the bankers’ association president, Rod Brown, said in a statement. “Given the poor credit rating of California, the worst in the nation, banks may be hesitant to extend credit to the state.”

At the White House, which has seemed flummoxed by California’s woes, President Obama’s spokesman, Robert Gibbs, said Thursday, “We’re going to continue to watch the situation in California and in other states throughout the country.”

Lord willing, this will go on until mid-Fall and beyond. Both sides of the debate have used very strong, unapologetic rhetoric which will make backing down all the more difficult.

It should make for some fun fireworks over this holiday weekend. It harkens back to the revolutionary period debate of state vs. federal rights. Much has trended toward federal over the past few decades; perhaps Schwarzies will unwittingly provide some slowing of that trend.

Bank Of America Decides To Accept California IOUs

The Bank of America decides to make a firm commitment to accept Schwarzies! or, at least for one week...

In a pound the table "we support you California" moment, B of A had this to say about Schwarzie acceptance:

“To support our customers, while giving the government additional time to pass a budget, we will accept California state-registered warrants - or IOUs -from existing customers and clients,” the bank said. “Based on state disbursement estimates, we will accept the registered warrants through July 10.”

Richmond-based Mechanics Bank said late Wednesday that it, too, will accept California IOUs from the bank's "established customers."

Wells Fargo and Chase had not made a decision as of Wednesday evening on whether to take the IOUs. [emphasis added]

We will keep everyone up to date on when and how Schwarzies hit. Today is D-Day in California. We are so excited about this new fiat currency. If this "works", just wait for other states to do the same. It will be all the fun of the 19th century all over again.

I smell a Federal vs. State power battle brewing if this catches on. We will see how far and long The Administration lets this go on.