When The State Of California Defaults On Its Bond Debt

My readers I am a nice person who is well mannered and hates loud noises and aggressive people. I don't own a gun. I love animals. I always hate to be the bearer of bad news.

I attended a board meeting where the state of local government finances in California was discussed. It was a sobering briefing. I came away with the distinct impression that the State of California will be forced to default on its massive debt in the near future.

What happens the day after such a bad event?

The first consequence will be a drop in the stock market. All of a sudden any US debt including US Treasuries will be suspect. Interest rates on these debt obligations will increase to attract buyers. The US dollar will drop against other currencies.


Owners of State of California bonds and unions representing the multitude of California will realize they're in big problems. Losses in the hundreds of billions of dollars will be on the horizon. These groups will head to court as fast as possible. Suits will be filed in US District Courts in Los Angeles, Sacramento, San Francisco and Manhattan. All of these suits and cases will end up being consolidated in Manhattan under one senior US District Court judge. If a person,couple or business goes bankrupt such cases go to courts designed to handle bankruptcies. No courts exist if a province,state or nation goes bankrupt. The court will be in almost uncharted territory.

The second consequence will be a political upheaval from Sacramento to Washington, DC and onto other world capitals. Governor Jerry Brown and California senators Diane Feinstein and Barbara Boxer will ask President Obama and Treasury Secretary Timothy Geitner for a bailout. The California congressional delegation will join in the request. They will get a sympathetic hearing and promises to help.

Any possible bailout will require legislative approval from the US congress. With the new ultra-conservative Republican majority in the US congress such a bail out has no chance of passing. The US Department of Treasury or Federal Reserve might attempt to "go through the back door" and buy up defaulted bonds. I'm skeptical of this possible solution.

The third consequence is that the State of California will be forced for the first time in decades to live within its means. Spending will have to be cut to match revenues. Social programs will be cut. Thousands of state employees including teachers will find themselves out of work. It's possible that money would not be available to pay them even unemployment benefits. Large construction projects like the new Bay Bridge in San Francisco might shut down. Medical care to the poor will be curtailed. Highways will not be repaired. Vendors providing goods and services to the state will go unpaid and business bankruptcies will follow with many more job losses.Think about all of the state functions we depend on and let your imagination consider all possibilities.

The fourth consequence of this default will be that the people of California and the State of California will "no longer have control of the purse strings," so to speak. The US District Court will take charge of all financial matters and decide who will and will not get paid. The court will see its first obligation to attempt to protect the bond holders and state employees. If we look at the General Motors and Chrysler bail out, we will see that bond holders and employees took huge losses. The unions were given some ownership interest in the companies.

The court will also look at assets to liquidate to pay off some of the creditors. Real estate and vehicles would be sold. Perhaps San Quentin Prison would be sold to developers. Perhaps some state parks and nature reserves would be sold to private investors. The next assets of interest will be the CalPers pension fund for State of California state employees. Normally such assets are "off limits" in bankruptcies. But who knows what the court may decide? Many workers enjoying high pensions might find their pensions cut to the Federal pension maximum for defaulted pension funds of $54,000 US per year. Employees expecting a comfortable retirement might not have any pension left at all.

The fifth consequence of this default will be that hundreds of thousands of other workers around the world whose pension funds invested in State of California bonds will find massive losses in their retirement funds.

The sixth and worse consequence of this event will be a loss of confidence that will reverberate throughout the whole world. Any economist will tell you that loss of confidence is what leads to great depressions. Also the plague of default will spread with other states in bad financial shape such as Illinois.


There will be many losers in this default. Right-wing Republicans feel that the only way to clean up the State of California fiscal mess is a sovereign default. These people cannot imagine the human suffering this event will unleash.

Who will win in this torrent of human suffering and destabilization? It will be a boom time for lawyers and law firms. Speculators who bet on such events will make huge profits.