California’s Leaders Focus on Climate Change While its Finances are not Sustainable!
I have been an investment manager and financial analyst for over 30 years. During that time, I have evaluated hundreds of companies as stock or bond investments. Many times, I have seen once marque companies gradually fall into the financial ruin due to poor decision making.
While I am not a municipal bond expert, I do see comparisons with California’s current financial mess to those infamous corporate disasters.
Here are my business minded observations:
1. Losing High Paying Clients: California has lost a substantial amount of large tax paying companies (along with its high-income employees) from various industry groups ranging from energy to financial services. The list is long and continues to grow: Charles Schwab, X (Twitter), Neutrogena, Parsons, CBRE, Coremark, McKesson, Oakland Raiders Football, Hewlett Packard Enterprises, Tesla, Toyota USA – now add SpaceX, Chevron & Oakland As baseball to the California departure list.
2. High Costs versus Competition – California’s individual income tax rate ranges from 9.3% to 12.3%. C-Corporations pay a flat tax of 21%. By comparison, Texas has no individual or corporate taxes, and nearby Nevada has no individual tax and a business gross receipts tax of 6.85%. In business terms, many companies are finding the price tag to work & live in California is not competitive to other region of the U.S..
3. Mounting Debts and Obligations: According to the Hoover Institute, “California’s state and local government debt is roughly $1.6 trillion, which includes a proper accounting of the state’s unfunded liabilities. To put this in perspective, this works out to about $125,000 of debt per California household and exceeds the annual GDP of all but 13 countries.”
Worse yet, there is no end in sight to the state’s appetite for indebtedness. Californians voted on $20 billion in new debt (on top of $35 billion previous approved but not yet used):
· Measure 2 – This ballot measure would authorize $10 billion of bonds to build and repair facilities at K-12 public schools and community colleges.
· Proposition 4 – Authorizes $10 billion bonds for water, wildfire, land protection and climate change measures.
What compounds the problem is as the maturing bonds will need to be refinanced at much higher levels of interest as investors will expect more in return for today’s inflation.
4. Severe Negative Cashflow– According to the Legislative Analyst’s Office (The California Legislature’s Non Partisan Fiscal and Policy Advisor), “The state already faces a significant deficit this year—we estimate it totaled $58 billion under the administration’s revenue forecast at the time the Governor’s budget was proposed in January. However, recent revenue collections data reflect even further weakness relative to those estimates. Specifically, our forecast is about $24 billion below the Governor’s budget across 2022‑23 to 2024‑25….This would expand the $58 billion estimated deficit to $73 billion under our updated revenue forecast.
5. Non-Competitive Operational Cost structure – According to Wikipedia, Government is California’s largest industry with about 2.5 million employees and is the third largest contributor of its GDP. When compared to Texas, California’s state and local government revenues and spending are 60 percent higher on a per-resident basis. In business terms, California’s cost structure is bloated compared to its state competitors.
6. Management Issues – While California’s politicians & bureaucrats focus on environmental, social and governance (ESG) issues, it has taken its “eye off the ball” of the fiscal bottom-line. A publicly traded company committing the same economic sins would probably find the value of its equity & bonds being punished by investors.
Simply put, when a company (state) is losing is biggest customers (taxpayers) to lower cost competitors (states), 2. Debts and interest costs keep growing, 3. bloated operations and a severe negative cashflow situation – warning bells should start going off!
What can be Done:
California currently has the sixth largest economy in the world. But, unlike a sovereign country, it can’t print currency to pay its debts. This is why U.S. treasury bonds are considered risk free.
Here are a couple of my suggestions to stabilize the situation:
1. Stop the exodus of CA taxpayers by fundamentally changing the relationship with business (a partner, not an adversary).
2. Adopt the government practices of competing states (i.e., part-time legislatures).
3. Pay off debts by developing the untapped natural resources of natural gas, timber & mining using environmentally friendly technologies & practices.
4. Consider issuing a “California Crypto” (a stable coin based on the value of CA’s natural resources.) to provide the financial flexibility digital assets can offer to pay off debt.
In 1914, when the “unsinkable” SS Titanic hit the iceberg, it took a long time to sink as musicians play songs on the gradually tilting deck to blissfully uninformed passengers. The low interest rate debt party is over, and the Golden State’s butcher bills are coming in. The financial crisis is very real!
It is my opinion that the current market valuation of long-term California municipal bonds doesn’t properly reflect the risk of future insolvency. My general advice to California investors is to diversify out of concentrated municipal bond holdings into higher yielding income investments not tied to the state’s problems such as corporate bonds and preferred stocks. While these investments are no tax free, the higher tax equivalent yield more than offsets the touted municipal bond benefits.