Wyatt Buchanan, Chronicle Sacramento Bureau

Monday, February 22, 2010

(02-22) 04:00 PST Sacramento –

California’s dire and ongoing budget predicament is raising a tough – and touchy – question about the state’s finances, one that some at the Capitol do not want discussed: Is California bankrupt?

Leaders and would-be leaders from both major parties have raised the b-word in the past weeks, and the Golden State is frequently labeled as bankrupt by people nationwide.

Federal law prohibits states from declaring bankruptcy and without a legal framework, assertions about California’s solvency are left to interpretation. But persistent multibillion-dollar budget deficits, cash crises, tens of billions of dollars in debt and other obligations have blurred the legal distinction.

“California is deeply in debt. You could say that it’s bankrupt,” Attorney General – and presumptive Democratic gubernatorial candidate – Jerry Brown told a group of young Democrats earlier this month.

Republican U.S. Senate hopeful and former Hewlett Packard CEO Carly Fiorina raised the specter of bankruptcy in a discussion with Southern California business owners. And Republican Assemblywoman and retired banker Diane Harkey of Dana Point (Orange County) said the state is “literally bankrupt.”

Protecting state’s reputation

She compared the state’s situation to a family with a mortgaged house, maxed out credit cards and zero savings. She said her outspokenness on the topic at public meetings and other forums has caused some at the Capitol to tell her she is apocalyptic, and she said she has been asked to quiet down.

“It would be nice if we could hide our problems like nobody knew about them, but the bond market is watching. It’s not a secret,” Harkey said, adding later: “I’m scared. I want to get the state fixed.”

Statements like Harkey’s could actually hurt the state, said Tom Dresslar, spokesman for Treasurer Bill Lockyer.

“You might score some political points by saying the state is bankrupt, but you’re hurting taxpayers when you do that. We are not basically bankrupt,” Dresslar said. “When you have that kind of talk out there and it makes it into the papers, it poisons the market when you go to sell bonds.”

He noted a recent report done by the Fitch credit rating agency that said if public officials actively discuss bankruptcy, “Fitch will assess whether the entity’s current rating should be maintained.” A lower rating makes it more expensive to borrow.

Although there is no legal definition of bankruptcy for a state, smaller municipalities are able to declare bankruptcy, like the city of Vallejo two years ago and Orange County in 1994. The definitions differ depending on the type of bankruptcy, but generally, municipal bankruptcies occur when a government is unable to pay its bills in the immediate future and/or through the next fiscal year, according to bankruptcy experts.

That won’t happen in California, state financial leaders say, because the lowest the state could fall financially would be to miss a debt payment. That hasn’t happened since the Great Depression, but California owes $8.8 billion in short-term loans that have to be paid off by June and almost $120 billion in outstanding bonds and interest that will be paid over decades.

Over the next 16 months, the state has a $20 billion deficit in the general fund budget. That’s the equivalent of nearly a quarter of the current spending plan of $84.5 billion. Much of that spending is locked in because of voter initiatives and federal mandates, limiting options for lawmakers. The deficit this year is more than the state spends on higher education and prisons combined.

The state’s pension fund, CalPERS, has $16.3 billion more in liabilities than assets at the latest calculation, although that number fluctuates with the system’s investment portfolio. Adding to that, a state report released this month calculated that California also faces a $51.8 billion bill – in 2009 dollars – for the health and dental benefits of state retirees and future retirees.

State Controller John Chiang, who made that report, said, “No, we are not functionally bankrupt.” He said California would reach its breaking point if there were court intervention due to debt default.

“That’s our equivalent of going into bankruptcy,” said Chiang, adding that, “I don’t want that to be put in the real, serious realm of discussion.” The state Constitution mandates that debt service has the second highest priority for payment, after only education, and the state continuously receives tax revenues.

Lacking cash to pay debts

But while California has had steady cash to make those payments, it has not always had the cash on hand for its other obligations. Last year, the state issued 450,000 IOUs to vendors and to residents awaiting state income tax returns and halted construction on thousands of infrastructure projects. The state has the lowest credit rating of any state in the nation, although it still is above junk-bond status.

If the state falls to junk status, some investors would be unable to buy state bonds, making it even more difficult for the state to borrow money and infuse cash into its coffers. Either way, it now costs the state more to borrow the money it needs to function.

Chiang also published a cash-flow forecast this month predicting that over the next 10 months, even if lawmakers adopt Gov. Arnold Schwarzenegger’s plan to balance the budget, California will have to borrow multiple billions to pay its bills later in the year. Cash-flow borrowing is common and has been necessary for the state for more than two decades due to the cycle of when bills are due and when revenue comes in, according to the controller’s office.

Another cash shortage this summer could mean more IOUs and other delayed payments, but Chiang and others are making strong assurances the state will have no trouble paying its most necessary bills.

“Going back to the Great Depression, California has never missed a payment to a debt holder or a bond holder and we will continue to move heaven and earth to make sure that never happens,” said H.D. Palmer, spokesman for the state Department of Finance.

The state’s finances are a bigger picture than just the infamously indebted $84.5 billion general fund. Including bond funds and special funds that by law have to be spent for specific purposes, the budget is $119 billion. Those funds are continuously depleted by lawmakers in an effort to fix the general fund, and they have to be paid back eventually.

On the asset side of the balance sheet, the state also owns billions of dollars worth of property and structures, scenic parks and other holdings.

California’s overall balance sheet has $34 billion more in net assets than net liabilities, according to a controller’s report from 2008, the most recent published. The report also showed the ratio between assets and liabilities declined 25 percent from the year before.

Jack Ayer, a UC Davis professor of law emeritus and a former federal bankruptcy judge, said a fair measure of an insolvent state would be if its assets are worth less than liabilities and if it could not pay all of its bills. The real-world outcome of that would be banks no longer lending money to the state, he said.

Considering state’s assets

“The banks are happy to keep lending – they don’t want to stop – but if they aren’t going to get paid back, they are going to stop,” Ayer said. And while the state does have assets, a fire truck or a courthouse doesn’t have much value to any entity other than the government, he said.

To read entire story, click here.