5 Reasons Why the Feds Shouldn't Bail Out CA

Even before California Governor Arnold Schwarzenegger began issuing IOU's in July, some pundits (Michael Maiello, for one) were calling on President Obama to bail out...
by | August 31, 2009 AT 3:00 AM

Even before California Governor Arnold Schwarzenegger began issuing IOU's in July, some pundits (Michael Maiello, for one) were calling on President Obama to bail out the (once) Golden State.

The Obama administration was having none of it.

"We'll continue to monitor the challenges that they have," said White House spokesman Robert Gibbs at June 16, 2009 press briefing. "But this budgetary problem, unfortunately, is one that they're going to have to solve."

By now, California has passed a budget and is getting billions in stimulus funds, but the crisis in Sacramento is far from over. The structural budget gap between expected costs and expected revenues isn't going away, as this report shows.

So it is very likely that the Obama administration will be faced with a politically important state swamped with red ink heading into an election year. What to do?

Those with long memories will recall that President Gerald Ford was adamantly opposed to federal assistance for an underwater New York City in 1975--for a few weeks, anyway. For Ford, a bailout wasn't an "answer to the problem, because they just delay, delay; they carry on, perpetuate the mismanagement we have really had in New York City."

On October 29, 1975, Ford gave a speech strongly opposing federal assistance. The next day, the New York Post ran a front-page, six-word headline that would haunt Ford right out of office: "Ford to New York: Drop Dead." Less than two months later Ford offered the city a $2.3 billion loan. The damage was done, however. The following year, New York would go for Jimmy Carter in a tight race--costing Ford the presidency.

Like New York, California is an important state politically. Given the current economic and political climate, with federal bailouts already going to Wall Street firms, General Motors, and others, the pressure for a bailout will likely increase with time. Here's five reasons why a fed bailout is a bad idea.

#1 - Necessity is the mother of invention: In business or in government, crisis spurs change. California has long been seen as "ungovernable," combining a highly ideological split in the legislature with an active, often irrational initiative petition system. (Voters have simultaneously voted for tight tax controls and generous spending provisions.) A bailout will merely mask the harsh reality of fiscal crisis, and little is likely to change. Without a bailout, things will have to change, because very soon these IOU's won't be worth the paper they are printed on.

#2 - Bailouts beget bailouts: Economists call this the moral hazard, the phenomenon whereby removing the negative consequences of injudicious behavior encourages more risky behavior. Other states will be looking at the California experience to find out if not paying your bills is a bad thing or simply an effective strategy for extracting more dollars from DC.

#3 - The politically impossible will stay impossible: California is broke because Sacramento is broken, and has been for a long time. The recall of Governor Gray Davis, the harsh rhetoric of Governor Schwarzenegger--nothing has altered the gridlock equation in Sacramento, where tax increases require a rarely-attainable two-thirds majority and reform is stymied by powerful public employee unions and other vested interests. Pouring money into a bucket with a hole in the bottom is a fool's errand. Fixing the problem is the only way to fix the problem.

#4 - A lack of ideas isn't the problem: In 2004, the California Performance Review Commission detailed over 1,000 recommendations with potential savings of approximately $31 billion over five years. Precious few of these recommendations have been adopted. The state still hasn't sold off the infamous MTV Malibu beach house, nor has it unloaded several state-owned golf courses--heck, even General Motors is doing that. There are many smaller, less sexy ideas that could actually save much more money. Altering the Medi-Cal program to streamline eligibility and do away with overlapping county systems isn't going to generate talk-radio chatter, but it could generate big savings. It won't happen, however, if a bailout removes the impetus for change.

#5 - If New York City can turn itself around, so can California: President Ford's strong stance against a bailout--even if it was short-lived--sent a message to the political powers in Albany and New York City. Before coming across with a federal loan (eventually repaid with interest), Ford watched as New York restructured its debt, increased taxes, and won concessions from the municipal workers' unions. "If we had shown any give, I think they wouldn't have made the hard decisions they have made," said Ford at the time.

Sigmund Freud defined neurosis as the psychological avoidance of legitimate pain. By this definition, California is neurotic, as are many state and local governments. With an underlying imbalance between tax revenue and cost structures, state and local governments are avoiding pain, delaying making needed changes in how they operate, choosing instead to allow federal dollars to mask their problems just a little bit longer.

Better, faster, and cheaper government can only be realized through the hard process of reform. More often than not, sacred cows really do make the best burgers. Pain hurts, however, and the president may not want to risk a headline that says "Obama to California: Drop Dead."

John O'Leary (johnoleary@alum.mit.edu) is the executive editor of the Ash Institute's Better, Faster, Cheaper web site, and coauthor of the book, "If We Can Put a Man on the Moon..." to be published by the Harvard Business School Press in Fall 2009.