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The 51st State

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Someone needs to call national seamstress Betsy Ross.  

America needs another star on the flag.

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If General Motors and Citibank are too big and too complicated to function successfully, then the same conclusion should be reached regarding the state of California.

One of every eight Americans calls the Golden State home. At more than $2 trillion, the economic output of California is greater than all but eight countries. California is responsible for generating 18.5 percent of the nation’s gross national product.  

The California economy is hugely dependent on exports. From Hollywood movies to wines, computers, electronics and video games, California exports more goods than any three states combined. Although acreage and jobs have been steadily declining, California’s agricultural sector is the most diverse, and by far productive, in the nation.  

While California is known for its idiosyncrasies, it is a state of terrific contradictions.  

It has voted for a Democratic President in each of the past six elections. Yet, it recalled a Democratic governor to install a Republican bodybuilder turned action hero, Arnold Schwarzenegger, in its top job.  California was the first in nation to vote for medical marijuana, but voted a ban on gay marriage.  

How About This for Contrast?

California’s public university system is the largest and most prestigious in the world, but the performance of its public school students is near the bottom rung.
California was the driving force in the housing boom that led to a period of unprecedented national wealth, and now it is the epicenter of the bust.  

[img]530|left|||no_popup[/img] While most states are facing cash crunches as the economy weakens, California's problems are epic.

Only three months ago, state officials agreed on a budget deal that closed a $40 billion gap by cutting $15.8 billion in spending, temporarily raising the state sales tax by a penny, borrowing $5.4 billion and using nearly $8 billion in federal stimulus funds.The state has also suffered mightily in the economic downturn. Its unemployment rate hit 11.2 percent in March, fourth highest in the nation, while its median home price dropped 54 percent over the past two years.

California is a state that can’t make up its mind. 

It has a state budget process that requires a two-thirds majority for passage, resulting in an annual ritual of delays and stop-gap measures. Through its arcane system of voter propositions, small but well-funded interest groups can cause the state to lurch from one extreme to the other. The “taxpayer revolt” that swept the nation in the 1970s was born out of one such state initiative.

In the wake of resounding voter rejection of a series of statewide initiatives that were touted to help the state close the budget gap, California is now faced with a $21 billion deficit that is projected to reach $27 billion in 2010.  The defeat of these propositions will likely result in larger class sizes, fewer cops on the beat and more public offices shuttered on weekdays.

Even though the bulk of the California budget initiatives went up in flames, one proposition did pass.  It bars pay increases for state elected officials during budget deficits.

Could the message be any clearer?

Arnold’s Crumbled Reputation

Voters selected the Governator because they believed that he could hammer the runaway state budget into line. In spite of his tough talk, Arnold discovered that rounding up votes in the California legislature is like herding cats. Conan the Governor staked a lot of his political capital on the defeated budget propositions, and now looks more like a girlie-man than a terminator.

Schwartzenneger has gone to Washington; hat-in-hand.  At this point he’s not looking for more federal bail-out assistance – although he won’t turn it down.  Instead, along with other state officials, he is looking to the federal government to extend loan guarantees to California.  

California is not the only state trying to get the federal government as a co-signer. It’s simply the biggest, and in the deepest hole.

State and federal lawmakers have pressed the Fed and Treasury to extend support to municipal securities since the Troubled Asset Relief Program, or TARP, was introduced last year. Municipal bond sales tumbled after the bankruptcy of Lehman Brothers Holdings Inc. in September.

The Federal Reserve will tell a congressional committee today that it is reluctant to extend guarantees to California and other municipal market borrowers struggling to sell bonds. You can’t blame them.  According to the credit-rating agency Moody’s Investor Services, California has the lowest rating of any state, and simply is a bad risk.
 
Like General Motors, the best solution for California may be bankruptcy court.  

Cities and counties like Orange County in Southern California have done it. Even archdioceses within the Catholic Church declared themselves insolvent after being hit with multi-million-dollar sex scandal lawsuits.

If the governor, the legislature and the voters can’t reach an accord, let a bankruptcy judge sort it out. He can make the hard choices without having to worry about re-election.  

In the end, maybe King Solomon had the best solution: Cut it in two.

John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com