Is California the Next Greece?

California, like Greece, has run out of options. Fortunately, America has no better laboratory for how to deal with California's budget crisis than watching how the eurozone will deal with Greece.

Last December, the Los Angeles County Chief Economist, Jack Kyser, said “no one really knows what will happen” if California defaults on its over $60 billion of general obligation bonds backed by the state’s general fund.  Now we know.  Greece -- for the moment running deficits of about one-eighth of its GDP -- is a useful example to the American experience again, probably for the first time since the Founding.

California, like Greece, has run out of options.  Their circumstances are eerily similar:  theoretically independent sovereigns in a federation-style broader economic system, beleaguered by decades of an overspending legislature, saddled with debt, and without the credit to borrow any more money.  Both can repudiate their debt in a way only sovereigns can.  Add their large and powerful public employees unions for the maximum possible discord.  Their federation mates, here the United States and the eurozone, are deeply concerned about both this particular situation and the signals they will send to the next special pleader with the same situation inside their respective group, such as Portugal or New York.  Both, for reasons of instilling confidence in their economies, want also to create the impression that all is and will remain well.

The same structural impediments to fixing the underlying problem that Greece’s bailors can point to also apply to California.  Neither the European Central Bank nor the European Union itself can control Greek taxing and spending, even if it is above what Greece has agreed to by treaty.  By rule, other eurozone countries cannot loan money to Greece when its deficit is over its agreed limit.  The American federal system, including with constitutional law helping delineate it, restricts the conditions the federal government can place on state legislatures in exchange for federal money, even if there is a decision to help.  The biggest difference between the U.S. and the EU is that the American federal government can tax its citizens and give the money to a state.  But expect to hear calls similar to George Soros’s as to Europe and the tax power that, if only the federal government were more empowered (i.e., if U.S. states could declare bankruptcy like localities can, which would allow federal courts to arbitrate state obligations) this problem would be considerably less dire.  It may not be a popular argument right now, though, that the answer to governmental failure is more power for the larger government.

But even if some arrangement can be worked out that gives the federal government satisfactory guarantees that the money can be repaid and the problem actually solved at the state level, whether it is prudent or fair to do so is the identical question in Frankfurt and Washington.  In neither the Greek nor Californian case do we consider a greater benefit to all in a bailout other than the self-evident recognition that it would be bad if a component of the federation should not be able to pay their debts as they come due.  In other words, solving the problem would only make Greece or California temporarily better off, but would prevent additional harm to their neighbors.  How much Germans should have to pay for Greece’s problems to maintain a eurozone is a slightly less difficult question than America’s, since one might have guessed (as Soros claims he did) that a currency without a treasury might run into such problems.

But to a Virginian, who for hundreds of years could have never conceived of his money being used to help fund a profligate, other, state government, the question produces even more problems than the future behavior of California or its successors.  Even if there were enough money to go around, which there is not, the encouragement of political blocs within federal or Union politics based solely on state government bailouts is so distasteful as to merit suffocating the notion in its crib, both here and there.  That another state needs better leaders is not something any given state can prevent, so the American system seems to oblige the well-run state very lightly, and likely ought to.   The eurozone may disagree for Greece.

This timing presents a unique opportunity for the US.  If one wants to solve the states’ budget crises without creating incentives for California or another state government to become a permanent welfare case for all the others, America has no better laboratory for how to deal with California than how the eurozone will deal with Greece.  In that sense, too, it is far preferable that their crisis broke first.