Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

Fourth California Bankruptcy Comes Knocking

Monday, July 23rd, 2012
By for Profit Confidential

Fourth California Bankruptcy Comes KnockingJust outside Los Angeles is the City of Compton, home to 93,000 people…a city running out of money. As the city treasurer eloquently put it, he has $3.0 million in cash and $5.0 million in bills due in the next month. (Source: Reuters, July 18, 2012.)

If debt restructuring decisions are not made soon, the City of Compton could file for bankruptcy as early as September.

Due to the fact that Compton has a $43.0-million budget deficit hole, it has been unable to secure a line of credit to get it through a difficult period. The reason why it can’t secure a line of credit is that the budget for 2012 is forecasting a further budget deficit of $9.0 million!

The city warns that it needs to make critical repairs to its water system in order to bring it up to code…and that will add another million dollars to the budget deficit!

The issues plaguing Compton were the same factors that took down the other three cities in California and are threatening to take down many more cities and states across the U.S. as budget deficits grow: falling tax revenues due to a drop in house prices, large pension budget deficits, generous public employee pay, and weak economic growth.

Speaking of the bankrupt California cities, one of them—San Bernardino—can now only provide services to its citizens on a cash basis. (Source: CBS Los Angeles, July 19, 2012.) San Bernardino is asking the State of California to assist, because it may not be able to collect the trash this week. The city is warning residents not to leave the garbage outside for too long or it will become a health issue.

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The Federal Reserve is so concerned about the budget deficit situation, it created the State Budget Crisis Task Force to study it.

The study simply confirmed what the states and municipalities have already been saying. Medicaid, the federal-state health-care program for the poor, is eating away a bigger portion of state budget deficits than spending on school education.

The study also highlights the fact that pension costs are overwhelming budget deficits. Another disturbing trend is that, to close budget deficits, cities are cutting their funding of local colleges by a significant percentage. That in turn is increasing tuition costs for the average citizen, which is making it harder for the average person to attend college and so places the U.S. on a precarious path of weak economic growth for the future.

Dear reader, the above is evidence that this issue will continue to take on greater and greater importance, because it does affect the country and its economic growth potential. (See: “Madness in Pennsylvania and One More Bankruptcy in California.”)

The more pressing problem is that, as the budget deficits get worse, individual states will certainly come knocking on the door of the White House for answers. Does the White House have any solutions to the budget deficits or will money printing be needed to solve the problem? I believe the answer is obvious.

Michael’s Personal Notes:

More Americans are taking out 401(k) loans and more Americans are defaulting on their 401(k) loans.

Members of the Brookings Institution and Navigant Economics have released a study that concludes that, since the financial crisis hit in 2008, Americans are defaulting $37.0 billion a year on loans taken from their 401(k)s! (Source: CNN Money, July 17, 2012.)

The research notes that, in 2008, the default rate on 401(k) loans was 9.7%. Since then, the default rate has almost doubled: remaining in the high teens, with the peak being 19.8% in 2010, and the current rate running at 17.4% per year. This is an economic recovery?

Americans who cannot qualify for regular loans are taking them against their 401(k)s to pay for unforeseen expenses or to cover day-to-day bills in this supposed economic recovery. The researchers uncovered that the higher default rate is due to increased job losses in this supposed economic recovery.

With more Americans losing their jobs, they have no capacity to pay back their 401(k) loans and so have no choice but to default in this failed economic recovery.

The study also points to the fact that more and more Americans are taking out loans against their 401(k)s, because they have no choice; they’re desperately trying to maintain their standard of living as the economic recovery falters

It’s ridiculous: the study reveals that, in 2011, 18.5% of all Americans who had 401(k)s took out loans in this supposed economic recovery!

I’d argue, dear reader, that 18.5% is probably closer to the real unemployment rate in this supposed economic recovery. The people who are taking out these loans are people in their 40s or 50s who have worked hard and attempted to save for retirement.

Now they have no alternatives left; as the unemployment rate rises, they lose their jobs, and cannot find other work. Everyone can understand how they want to maintain their standard of living for the longest possible time. Of course, taking on more loans is only a temporary solution. Americans need jobs, but with a nonexistent economic recovery and a rising unemployment rate, the U.S. economy is not accommodating them.

This is a vicious circle, because these people in their 40s and 50s are in their prime earning years. These are the years where they should be able to spend more comfortably—which would help an economic recovery—and save more for retirement. Now more of them are taking loans against their retirement to pay for their basic necessities!

In light of these facts, consumer spending is being severely strained in this country, which means that economic growth will be limited. As if we didn’t need any more headwinds, if the unemployment rate does not come down soon, these people will not be able to retire comfortably. The typical thought that retirement means more spending on the part of retirees which will stimulate economic growth will not hold true, because there will be no money for retirement!

This is not a regular recession. It has gone on for too long—four years now and counting—and it is hurting the average American greatly. (See: “Moving Closer and Closer to a U.S. Recession.”)

If the unemployment rate is not repaired (and I don’t see how it can be), consumer spending will continue to come under pressure. As consumer spending accounts for 70% of GDP growth, the U.S. economic growth story is in big, big trouble.

Where the Market Stands; Where it’s Headed:

This morning, the market has sold off sharply and the media is quick to blame Europe’s woes again, particularly the concern that Greece won’t be able to make good on its bailout promises.

Of course, I see Greece (and Spain, Italy or whatever country you want to add into the pot) as the scapegoat for inexperienced reporters. The real truth is that investors are finally understanding that economic growth worldwide is slowing; maybe too quickly. Sure stocks offer good value compared to low-yielding bonds. But as Recession Part II gets underway, corporate profits will erode, putting pressure on stock dividends once again.

Technically speaking, the Dow Jones Industrial Average has put in a picture perfect “head and shoulders” pattern. The door is almost closed on the bear market rally that started in March of 2009.

What He Said:

“Many of today’s consumers have purchased properties with very little down payment. They’ve been enticed by nothing-down, interest-only, second and third mortgages. Bottom line: The lower interest rate environment sucked consumers into the housing market big-time. And that will eventually cause us all problems.” Michael Lombardi in Profit Confidential, June 22, 2005. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.

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Fourth California Bankruptcy Comes Knocking, 5.5 out of 10 based on 2 ratings
  • Warren White

    Democrats

  • Warren White

    After 12 years of Republican Congress provided prosperity, including 4 Republican Congress budget surpluses…
    The Pelosi/Reid/Obama Dem Congress ruined GWB's last 2 years.
    Obama inherited his own Democrat Congress recession, bankrupting Dem spending/Deficits

  • Charles Miller

    Health care was not working before so what makes u think it will be that much worse?

  • Charles Miller

    U would think that all those CEO's and upper management would think that something is wrong when they collect millions of dollars in compensation!!They cannot and do not run their corporations or do their job with absolutely no help. That is exactly what is wrong with our country: too many fat cats that do not remember where they came from.

  • Charles Miller

    What goes up must always go down: for California it was the lack of planning for when the economy came down.Scwartzenner was not the only one: I bet Reagan did not do much for them but took alot of credit.

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Michael Lombardi - Economist, Financial AdvisorMichael bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely, reading every book he could find on the topic and taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Some of the stock recommendations in Michael's various financial newsletters have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management. Michael became an active investor in real estate, art, precious metals and various businesses. Readers of the daily Profit Confidential e-letter are offered the benefit of the expertise Michael has gained in these sectors. Michael believes in successful stock picking as an important wealth accumulation tool. Married with two children, Michael received his Chartered Financial Planner designation from the Financial Planners Standards Council of Canada and his MBA from the Graduate Business School, Heriot-Watt University, Edinburgh, Scotland. Follow Michael and the latest from Profit Confidential on Twitter or Add Michael Lombardi to your Google+ circles

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