Thursday, January 14, 2010

California Downgrade Presages U.S. Credit Problems

California’s debt was downgraded again as Standard & Poor’s worried about the state’s cash flow in March and April. Tax revenue has been less than the state’s budget called for — $20 billion less — and it could run short of money for a few weeks while waiting for income tax payments to come in in April.

California is not the only state where the budget is not working out as planned, and many local governments, depending heavily on taxes on employment and real estate, are faring worse. This is leading to massive job cuts this month, and the situation for state and local governments may get worse before it gets better, as employment and real estate values have not yet hit bottom in most of the country.

The problems in California may also hint at future problems for the U.S. government. The idea of U.S. government debt being rated anything less than the best has traditionally been unthinkable, but if we have learned anything from the last two years, it is how quickly things that seem permanent can change. A flight to quality ironically favored U.S. government debt in 2009, but that may not continue this year. Economic conditions will be improving faster in most of the world than in the United States. At the same time, the United States, with its greater dependence on oil imports, faces a greater risk of inflation. If investors turn elsewhere, the U.S. government may have to adjust by borrowing less.

Update: Fortune this afternoon posted the story, “More and more states on budget brink,” covering many of these issues in more detail.