How Can California Not Go Broke?

— by Michael Lombardi, CFP, MBA

Okay, so we’ve all heard the news, The State of California is paying its bills with IOUs. California has declared a fiscal state of emergency. State offices are closed three days a month to conserve cash. State employees (235,000) have already seen a 14% cut in pay and the State has the lowest credit rating among other states in the U.S.

But California is not new to fiscal crisis. Back in 1992, the State issued IOUs because it couldn’t pay its bills that year either. And if you remember 1992, it was a bad year for the housing market, just like 2007 and 2008 were terrible years for housing.

Of the 278,000 home loan foreclosures that were in the process in May…of the 282,000 home loan foreclosures that were in the process in June in the U.S., the majority of these foreclosures were happening in states that saw the biggest home price increases during the boom days: Florida, Nevada and California. And, as the old saying goes, the higher they go, the harder they fall.

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Housing prices have taken a 50% hit in many parts of California and foreclosures are through the roof. That means severely declining property tax revenue. Add to that rising unemployment, slower retail sales, and few building permits being taken out, and the tax basis is shrinking. (I’ll bet Governor Schwarzenegger never thought he would have to deal with this type of crisis.)

My concern, as you have been reading in the pages of PROFIT CONFIDENTIAL, is rising interest rates. What will happen to real estate if interest rates rise? Real estate prices will go down. That means more foreclosures in states like California. This is not like 1992 when interest rates began to fall and the housing market started to pick up.

Let’s face it; the only savior for California can be the federal government. But what happens if Washington does bailout California? They’ll have a line-up of other states asking for bailout money. This will be an interesting one to watch.

Michael’s Personal Notes:

I don’t know much about British Prime Minister Gordon Brown, but from what he said in advance of the G8 Summit in Italy, I like him. From what I get from comments from Brown and reporters following him at G8, Brown is expecting a second economic wave to hit from the credit crisis. This is a far cry from most world leaders, who believe the worst is behind us. I have to agreement with Prime Minister Brown. In the years ahead, we will need to deal with the ramifications of the credit crisis, primarily high unemployment, and maybe even social problems.

Where the Market Stands:

We are not dealing with a happy stock market these days, as we had another big down day for the Dow Jones Industrial Average yesterday. Are we now headed back to the March 9, 2009, lows? Yes, I believe we will eventually test those lows, but we will not march straight there. For the benefit of my new readers: shortly after the Dow Jones Industrial Average hit 6,440.08 on March 9, 2009, I predicted that the stock market would recoup 30% to 50% of its loss and that the Dow Jones Industrial Average would turn positive for 2009. The Dow Jones did recoup 30% of its losses by May and the all-important index did move into positive territory for 2009 — but it was short-lived. With the market’s bounce-back being weaker than I hoped, this is not a good sign.

What He Said:

“Investors have been put into an unfair corner. Those that invested in stocks because they got caught in the tech boom (1999) have seen their investments gone. Now, those that have leveraged heavily to play the real estate game, because it is the place to be (2005), could see the same fate as the stock market investors. Thanks again, Mr. Greenspan.” Michael Lombardi, in PROFIT CONFIDENTIAL, May 27, 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.