Felix Salmon has a great series of posts, all worth reading, on a subject of emergin importance: state and muni defaults. It’s not a very well known subject just due to the fact that there haven’t been many state and muni defaults over the years.
And this one look looks specifically at the State of California, a state which we used to look at pridefully as one of the most beautiful, biggest economies in the world, but which is now for all intents and purposes broke. Worse than the UK probably. Of course if the UK defaulted, it’d send shockwaves throughout the global economy.
What then can we expect if California — famous for its political gridlock, particularly around issues of taxing and spending — decides to default.
Felix offers up some thoughts:
The more powerful argument why California won’t default is that a payment default is illegal under state law: California’s simply not allowed to default on its bonds. But what are the monolines going to do, sue? If California defaults on say a $1 billion payment which the monolines have to pay, then California owes the monolines $1 billion. If the monolines sue the state and win, then California owes the monolines $1 billion. It’s not clear that they’ve advanced very far. Could they start attaching state assets? I doubt it, somehow.
My hope is that the monolines would get their money back reasonably quickly — the unintended consequences of a default would force California’s dysfunctional legislature to wake up to the pettiness of its actions, and serious fiscal policies might finally be able to be passed. But I can’t say that outcome is particularly probable: the California legislature has shown no signs of being grown-up in the past, or even of moving in that direction.
And indeed the really nasty unintended consequences of a Californian default might well be felt outside the state, with the closing down of the municipal bond market nationally. Once California defaults, it’s hard to see any other state raising private general-obligation funds at any kind of interest rate it would consider acceptable.
Which brings us back to the moral-hazard play: maybe the Feds would bail out California, not for California’s sake, but rather for the sake of the municipal bond markets as a whole. But it’s hard to see where they would get the money, or how Congress would ever approve such an appropriation.
We are all California, hail the Governator!