A New York Solution for Bailing Out California

[w¡n9Nµ7 §£@¥€r 123]

"Ford to City: Drop Dead." That was the New York Daily News headline in 1975 when President Gerald Ford promised to veto any federal bailout of a bankrupt New York City. President Barack Obama has responded in similar fashion to California's current plea for help, explaining that many other states have severe budget problems. Besides, the Recovery and Reinvestment Act just gave the states $140 billion.

This is the right response. If Washington bails out Sacramento's $26 billion deficit, the odds are high that California legislators will once again kick their deep-seated fiscal problems down the road. However, we should recall that Ford's veto threat was not the end of the story. Ultimately he did intervene, and so too may Mr. Obama. The history is useful in thinking about what to do today.

During the early 1970s, New York city's government lived well beyond its means, and in April 1975 it was shut out of the public debt markets. The state then created the Municipal Assistance Corporation (MAC), a private body, to help. But despite support from Albany and threats of a wage freeze, not enough money could be raised to meet the city's cash needs.

Albany then set up a Financial Control Board to take over New York's fiscal affairs. It required the city to submit a "rolling four-year financial plan to the Control Board prior to the beginning of each City fiscal year and, to modify the plan as necessary from time to time" under state rules. MAC could dole out money to the city only if the plan was followed. New York was effectively put in receivership.

As part of the deal, municipal unions and New York banks bought city securities. Gov. Hugh Carey promised to balance the state budget, and there was a three-year moratorium on redeeming $1.6 billion in short-term city debt held by individuals. The city with the highest taxes in the U.S. also got a tax increase. Washington then reconsidered. President Ford agreed to an annual $2.3 billion loan for several years at an interest rate 1% above the government borrowing rate.

Still, matters did not go easily. Helping the city hurt the state's finances, as MAC initially had to pay more than 10% interest to sell its bonds. There was a continuing struggle to get the city's fiscal house in order, and the U.S. Supreme Court had to rule that the pledge of state revenues as security for MAC bonds was constitutional. The jobs of 40,000 city workers (out of 300,000) were eliminated. But the budget eventually was balanced. By the late 1970s, New York City began to gain jobs. MAC's role ended in 1984, and despite ups and downs more than two decades of good enough performance followed.

Today, California is like New York in the 1970s. It has the lowest debt rating of any state, and its deterioration is striking. Three decades ago California had excellent highways. Now they are among the worst in the country. Its highly rated K-12 schools are also far down the list, and the best public university system in the world is in jeopardy.

The state's tax system desperately needs reform. Revenues in 2009 are down 27% from a year earlier largely because 1% of taxpayers pay 50% of income taxes and their capital gains have evaporated. These taxpayers have a clear incentive to leave the state -- and they are. One manifestation is the "Incline Village Effect," named after the community on the east side of Lake Tahoe, in income-tax-free Nevada, whose residents get socked if they spend more than 182 days a year in California.

There is talk of abolishing the legislature's two-thirds majority rule to raise taxes, but in such a cockamamie system this is a crucial defense against uncontrolled spending. A Tax Modernization Commission will soon recommend broadening and flattening the rate system, and its proposals could significantly improve the state's outlook.

But without serious reform, California's outlook is dismal. Rating agencies warn that the state's bond rating might be further downgraded,the state is already issuing IOUs in lieu of cash, and it could soon be shut out of the debt markets as New York City was in 1975.

If California paper can't be sold, pleas for federal funds will intensify. Like Ford, President Obama may reconsider and come to the rescue with a California Relief Program; let's call it CARP. Other states would no doubt demand similar bailouts, and the prudent ones would object to paying for California's profligacy. Like TARP for the banks, CARP might grow in scope and size, eventually becoming the Troubled States Relief Program.

But as we've learned, bailouts without conditions only encourage more spendthrift behavior. New York's MAC dealt with this by having two functions: raising money for the city and imposing discipline on spending. Because states, unlike cities, have sovereign power under Article 10 of the Constitution, it is unlikely the federal government could require California or other states to transfer MAC-like authority to a national body. But Washington might condition its support on the creation of such a private body within each mendicant state. Funds would be released to politicians on conditions, such as adherence to a long-term budget plan that would allow spending to grow only as fast as the economy.

Given that this would greatly constrain state politicians, there might not be a rush to sign up. New York City lost control of its fiscal affairs for a decade, so the states might opt to fix their own affairs. But if Mr. Obama does decide to bail out the states, he could do worse than follow the New York model.

Mr. Rowen is professor emeritus of the Graduate School of Business and senior fellow emeritus of the Hoover Institution, Stanford University. He helped to create the New York City-Rand Institute.

http://online.wsj.com/article/SB124701298016709067.html

[mawilson 2,133]

Good idea. Bail out one state and other states will run up their budget deficits, expecting a handout -

kind of what happened on Wall Street in the late '90s with the bailout of LTCM which started the

"decade of moral hazard" leading up to this crisis.

Balance your damn budget or drop dead, California!

[NickD 203]

My thought with how Milwaukee County is draining our state, would be to kick them out and let them be their own state. Our property taxes are going to rise next year by another couple of hundred bucks to help them out.

In my observations, just way too many people down there standing around and doing nothing. Their teachers demand super high paychecks, kind of like hazardous duty pay, but we only got a couple of bucks for that in the military. That mess was made by our government, they retire with high paychecks and we have to pay the bill.

Still think we either should return to our original constitution or have a major revolution. Our forefathers had the will, we are just a bunch of whims. Still can't find anything as to how much the British were taxing our tea, but can't be any thing close to how we are being taxed to death today.

[Ban Hammer 13,677]

Good idea. Bail out one state and other states will run up their budget deficits, expecting a handout -

kind of what happened on Wall Street in the late '90s with the bailout of LTCM which started the

"decade of moral hazard" leading up to this crisis.

Balance your damn budget or drop dead, California!

but but but they are a net contributor!

[w¡n9Nµ7 §£@¥€r 123]

but but but they are a net contributor!

That is a huge part of the problem.

For example, out of all the states, New Jersey gets the least amount of money back from DC per every dollar it puts in. Imagine if that were rectified and states all got back precisely what they put in. It would be a massive injection of our own capital back into our states, capital that is right now being confiscated by the Feds and sent to other states.

In other words, California would benefit greatly if it were no longer a net contributor.

[Ban Hammer 13,677]

but but but they are a net contributor!

That is a huge part of the problem.

For example, out of all the states, New Jersey gets the least amount of money back from DC per every dollar it puts in. Imagine if that were rectified and states all got back precisely what they put in. It would be a massive injection of our own capital back into our states, capital that is right now being confiscated by the Feds and sent to other states.

In other words, California would benefit greatly if it were no longer a net contributor.

why do you hate cali's bragging rights?

[NickD 203]

but but but they are a net contributor!

That is a huge part of the problem.

For example, out of all the states, New Jersey gets the least amount of money back from DC per every dollar it puts in. Imagine if that were rectified and states all got back precisely what they put in. It would be a massive injection of our own capital back into our states, capital that is right now being confiscated by the Feds and sent to other states.

In other words, California would benefit greatly if it were no longer a net contributor.

why do you hate cali's bragging rights?

I liked Ford as our president, country picked up under him, his key contribution was to do nothing, other guys just made trouble for us. Be better off if we eliminated that office.

[mawilson 2,133]

but but but they are a net contributor!

That is a huge part of the problem.

For example, out of all the states, New Jersey gets the least amount of money back from DC per every dollar it puts in. Imagine if that were rectified and states all got back precisely what they put in. It would be a massive injection of our own capital back into our states, capital that is right now being confiscated by the Feds and sent to other states.

In other words, California would benefit greatly if it were no longer a net contributor.

I don't buy this "net contributor" #######. The Federal government has a deficit too (and it's not going

away any time soon), which means it spends more tax dollars than it gets from the states.

So how much of that borrowed money goes to California and other "net contributors"?

[The_Dude 1,142]

but but but they are a net contributor!

That is a huge part of the problem.

For example, out of all the states, New Jersey gets the least amount of money back from DC per every dollar it puts in. Imagine if that were rectified and states all got back precisely what they put in. It would be a massive injection of our own capital back into our states, capital that is right now being confiscated by the Feds and sent to other states.

In other words, California would benefit greatly if it were no longer a net contributor.

Yeah, but who gives a sh!t about Jersey?

[AlHayatZween 2]

Do California's celebrities pay state taxes, or do the mostly claim residence in other states/countries?

[The_Dude 1,142]

Do California's celebrities pay state taxes, or do the mostly claim residence in other states/countries?

State taxes are paid according to where they are generated. Professional athletes have to pay taxes in every state that they play a game in. Makes accounting a nightmare.

[w¡n9Nµ7 §£@¥€r 123]

I don't buy this "net contributor" #######. The Federal government has a deficit too (and it's not going

away any time soon), which means it spends more tax dollars than it gets from the states.

So how much of that borrowed money goes to California and other "net contributors"?

Money sent to the states get chalked up as part of total federal dollars received. Whether a dollar received was generated through taxes or borrowed, it's still a dollar received. The point is, California (and states like NY, TX, NJ) receive less than 1 dollar for every dollar they contribute.

That said, who in the United States lends the Treasury the most money? Anyone buying federal paper, I'd be willing to bet they are also concentrated in states like CA, NJ, NY, TX. So really, not only do we pay more for our lesser fortunate brothers and sisters in Kansas and Mississippi, we also lend them our money.

Now just imagine if we got to keep our money and used the capital we lend the Feds to lend to local infrastructure projects...