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Four steps California should take to hedge against financial risks

Five long, recession-plagued years ago this month, I made a difficult but necessary decision as the state’s chief fiscal officer.

With only $6 in cash to pay every $10 of bills, California could no longer meet its payment obligations. In the months leading up to this moment, the state had already resorted to delaying the issuance of tax refunds, halting financing for construction projects and slowing payments to critical public programs.

The popular belief that California was “too big to fail” was shredded as the nation’s largest state was teetering on the brink of insolvency.

To conserve enough cash to make the state’s constitutionally guaranteed payments – including to schools and bondholders – I began issuing registered warrants, or IOUs, in July 2009.

We knew we had hit a historical low point when the Smithsonian National Museum of American History asked for a registered warrant “as an interesting addition to the story about recession and depression in the USA.”

In all, we issued 450,000 IOUs worth $2.6 billion during July and August 2009. While difficult for those Californians on the receiving end, the IOUs did buy enough time for the Legislature and governor to reach a budget agreement that began to solve our immediate cash-flow problems. Importantly, by not allowing the state to default on its constitutionally guaranteed payments, we protected California’s credit rating and its long-term access to the capital necessary to build its schools, roads and other critical infrastructure.

Today, as California’s economy rebounds, we have a much-improved cash position. In fact, for the first time since July 2007, the state ended its fiscal year in the black after paying back all money borrowed from Wall Street and the state’s 700 internal special funds and accounts.

But California traditionally has had a cyclical economy – meaning a downturn will be experienced at some point in the future. We also know that more than $6 billion in revenues will no longer be available by 2017 when temporary tax increases authorized by Proposition 30 expire.

To hedge against these known risks, I urge California to take the following steps:

The first is to adopt Proposition 44 on November’s ballot, which puts a small share of annual revenues into a rainy day fund. Additionally, I would strongly urge the governor and Legislature to view this legally required amount as a floor, and not the ceiling, of what constitutes prudent savings. In addition to helping keep the budget balanced during an economic downturn, this reserve will provide a buffer against future cash-flow disruptions, averting the need for payment deferrals or IOUs.

The second step is to undo the accounting gimmicks sprinkled throughout budgets adopted during the Great Recession. Without judging their value or necessity at the time they were written, we know we have the time and resources to unpin some of those changes, such as holding payroll by a day, or delaying payments to schools.

Third, the state should get serious about pre-funding the health care benefits promised to retirees. Unlike pensions, retiree health care is paid bill-by-bill with no savings or investment income to offset costs. This gives us little control over future spending on retiree health care, which almost always comes in at a higher-than-expected price. My office recently projected the 30-year cost of this program to be approximately $64.6 billion.

Finally, California needs to address the known problem that was documented by the legislative analyst in 2005 – the state’s revenues are more volatile than the economy. And California’s economy tends to be more volatile than that of the nation. The result is a heightened risk of a financial perfect storm in which revenues can swing wildly while it takes months before the Legislature is able to trim expenditures. This demands that the state develop and maintain greater levels of liquidity to absorb short-term financial shocks.

It is understandable to sometimes find yourself surprised by unexpected events. But there are major risks that are in plain view today that can and should be managed. And we must do so now, during this window when we can govern outside of crisis.

As stewards of taxpayers’ money, we should exemplify a management approach that controls the state’s financial destiny instead of continuing to react to external events or delaying action until compelled to do so by crisis. Thirty-eight million Californians and millions of California businesses that depend on the state deserve at least that much.

And the Smithsonian doesn’t need another IOU to add to its display.