As Governor Arnold Schwarzenegger, before a joint session of the California legislature, recently said:
Our wallet is empty.
Our bank is closed. And
our credit is dried up.
California will default on its bonds soon.
What does it mean? In the U.S. each of the 50 States are not allowed to declare bankruptcy, so when they run out of money they simply declare they cannot pay their debts, a condition known as a default. If this happened to a business, a city, a county, or you, or me we’d call it a bankruptcy.
Once California defaults, many other States will follow. The impact of California and other State’s debt defaults over the next 3-12 months will likely trigger collapse of the entire municipal bond market, with negative fallout for all other financial markets.
Many very large Bond funds and Money Market funds are required by their charter to sell any bonds where the issuer’s credit rating is less than “top” quality. Once California defaults its credit rating will be lowered below “top” quality and these funds will be required to immediately sell. Bond prices will fall.
Money market funds, most of which are no longer guaranteed by the FDIC nor the Federal Reserve, will be hit especially hard. Individuals who hold Money Market funds (thinking they are safe) will see their capital value cut significantly.
There will be no bailout for individuals.
What to do? Move all your money market funds into ultra-conservative, short-term US Treasury notes or into investment funds that invest 100% only in short-term US Treasuries.
Below is Martin Weiss’ explanation:
Day of Reckoning (Source.)
This is a day of reckoning for California and, ultimately, for all of America. Will our nation’s largest debtors meet their massive financial obligations? Or will many ultimately default?
California Defaulted on Its
Short-Term Debt Obligations
In lieu of cash, California is now issuing i.o.u.’s to meet obligations to vendors and citizens, postponing payments on its current liabilities.
But current liabilities are short-term debts. Ergo, based on this standard definition, California is already defaulting.
It’s not the same as defaulting on its bonds. But for reasons I’ll explain in a moment, I’m now more convinced than ever that a bond default is also coming.
Consider the importance of this week’s events …
If California’s creditors had a say in the issuance of i.o.u.’s, Sacramento officials might be able to deny they’re in default by implying mutual consent. But that’s far from the facts. The creditors had nothing to do with this decision. It was unilateral, a telltale aspect of debt defaults.
If the i.o.u.’s were as good as cash, Sacramento might also deny the D-word. But the sad reality is that, if you’re among those stuck with California i.o.u.’s, you have only two choices: You have to either hold them while you sweat and cross your fingers or you have to sell them at a steep discount — exactly the same choices facing bond investors after a default.
If all major financial institutions accepted California i.o.u.’s, that might also help Sacramento justify a continued denial of default. But the reality is that most banks are not accepting the i.o.u.’s, and no one could argue their reasoning is financially unsound.
Why accept a piece of paper at face value when it’s worth significantly less than face value on the open market? The nation’s largest banks already have enough troubles with toxic mortgages, toxic credit cards and toxic loans on commercial real estate. They’re not exactly anxious to pile on toxic California paper.
If, as in past episodes, California’s budget mess were mostly due to a political snafu, it could be argued that the i.o.u.’s are merely a temporary stop-gap. But that’s clearly not the case either.
To the contrary, California’s budget crisis is rooted in an unprecedented economic depression with 11.5 percent unemployment and the greatest concentration of mortgage delinquencies in the nation. Even if the i.o.u.’s are ultimately paid in full, California’s debt troubles are not going away.
Why I Expect a Default on California’s Bonds
Short of an 11th-hour rescue from Washington — where political resistance to bailouts has grown dramatically in the wake of recent federal rescues — it will be extremely difficult for California to avoid a default on its bonds.
The fundamental reason: A vicious cycle of budget tightening and falling state revenues.
The state cannot balance its books without inadvertently making the California economy — and its deficit — even worse.
When it cuts spending, it merely creates more unemployment and forces consumers to slash their own spending or default on their own obligations, driving the economy into a still deeper depression. And when it raises taxes, it has a similar impact.
Either way, the end result is lower revenues flowing into the state’s coffers.
But now California has over $28 billion in bonds coming due between now and October. How will it come up with the cash is a great mystery to me. Bond holders are certainly not going to be among those accepting i.o.u.’s.
Wall Street Rating
Agencies Also in Denial
The business model of Moody’s, S&P and Fitch is to sell their ratings to bond issuers; the ratings are bought and paid for by the very institutions being rated, including the state of California.
After multiple investigations of the Wall Street ratings agencies, Congress and the Obama Administration are proposing radical changes. But right now, it’s business as usual, and the egregiously conflicted business model of the Wall Street rating agencies still stands.
I believe that’s a key reason the rating agencies have not yet fully recognized the obviously dire state of California’s finances. And that’s why California’s state Treasurer can still claim Wall Street “doesn’t agree” with more realistic analysis like ours.
In effect, the state virtually pays them to hold their punches.
But despite these blatant conflicts of interest, the truth cannot be bottled up forever. Here’s what I see coming next:
1. Downgrade massacre: A series of multi-notch downgrades by Fitch, Moody’s and S&P, making it extremely difficult — if not impossible — for California to roll over maturing debts at any cost.
2. Worsening deficit: Surging interest costs and greater than expected declines in cash inflows, bloating California’s deficit even further.
3. Washington snub: A last-ditch effort to persuade Treasury Secretary Geithner and President Obama to reverse their earlier decision not to bail out California.
But Washington’s arguments against a California bailout are relatively firm: They’re already giving California billions through the stimulus package. If they bail out California, what will they say to the dozens of other states that line up on the White House lawn asking for theirs?
In contrast, arguments supporting a federal bailout of California sound like a hollow rerun of last year’s “bailout-or-meltdown” ultimatum by former Treasury Secretary Paulson to Congress. It’s a long-ago discredited approach to financial emergencies.
4. Default on California bonds: Despite Sacramento’s official mantra that a default is impossible and unthinkable, it happens.
5. Cascade of defaults: If giant California can default, the new assumption is bound to be that almost any issuer of tax-exempt securities can do the same. A cascade of downgrades and defaults by other states and municipalities ensues.