Meredith Whitney doubts CA recovery

June 5, 2013

By Wayne Lusvardi

California comeback? Maybe not.

Municipal bond expert Meredith Whitney was interviewed on June 4 by Steve Forbes in Forbes.com about her new book, “The Fate of the States: A New Geography of American Prosperity.” She is well known for predicting bank problems just before the September 2008 financial crisis.

She made this trenchant statement about California:

“What’s incredible is from 2008 to 2011 the U.S. G.D.P. (gross domestic product) grew 6 percent.  But California grew 1 percent to 2 percent.  But Louisiana grew in the high teens.  So you have an incredible divide between high single digit G.D.P. growth in the central corridor and basically next to no growth on the coasts.  It’s a rebalancing of the economy.  So the entire G.D.P. is two-plus percent.  It’s the tale of two very different countries, I think.”  

So California grew at 4 percentage points less (6 percent minus 2 percent), helping retard the national recovery.

According to Whitney, your future economic fate will depend on the fate of the state you are living in. Whitney had more to say about California in her interview than any other state.  And what she said is troublesome because many in the media have declared that California is making a recovery.  Gov. Jerry Brown also said in his State of the State address, “California is back, its budget is balanced, and we are on the move.”

More taxes not resulting in better things for kids

Whitney says that when government raises taxes, people think that kids are getting educated, getting school lunches, infrastructure is getting built or repaired, and public safety comes first.  The reality is that more and more taxes are going first for pensions and municipal bond obligations.

A prime example for Whitney is California, which last November passed Proposition 30, Gov. Brown’s $7 billion tax increase.

“A lot of that went to pension funds,” said Whitney.  “Money is going to pay for pensions, money is going to pay for bonds, and money’s not going to critical issues like education.  Because if you don’t educate, you can’t attract jobs.”

Indeed, shortly after Prop. 30 passed, the Caifornia State Teachers’ Retirement System announced it needed another $4.5 billion a year for 40 years from the state’s general fund to keep its fund solvent.

“Smart Money” not betting on California

According to Whitney, “smart money” is voting with its feet by choosing to build businesses in Texas and Louisiana instead of California.  Whitney asks, “What is the ultimate quality of life differential?  Do I really want to drive down the Pacific Highway every day?  Is it worth twice the cost to live in Texas, in Austin, and Wyoming?  How much are things really worth?” 

Whitney describes a “pension math mystique” whereby states target an 8 percent return to fully fund their pension obligations.  When states don’t generate an 8 percent return, “they’re automatically guaranteed to then reinvest to get back up to this high water mark of 8 percent.  And you know who’s paying for it?  Our tax dollars.”  She believes the current forms of public pension funds are unsustainable. The rate of return on the pension funds for the California State Employees’ retirement System was 7.75 percent, until it was dropped just a bit to 7.5 percent in March.

Here’s how Whitney describes what is likely to happen, “If your park closes or your park is unsafe all of a sudden, it affects you in a very major way.  And how quickly your fire truck comes to your hometown fire.  If they’re under duress in towns in California, 30, 40 minute response times.”  

“It’s over” 

Asked by Steve Forbes if “it’s over for towns in California,” Whitney responded: “It’s over. Yeah.”

A big bailout for California is not in the offing.  “Why would a Texan want to save a Californian?”  Whitney said every state is going to have to get to the point of forcing new workers into 401(k) retirement plans.  She predicted that, to generate the amount of political will needed to make improvements, things first have got to get worse.

The only state singled out by Whitney for courage to reform its pension systems is Indiana.  Another key reform that Indiana did is privatize.  By privatizing, Indiana got nearly $4 billion for paying down debt and investing in education. 

Whitney also said California is on the wrong track with its public-funded California High-Speed Rail project because it doesn’t make sense economically.  She cited Texas as a counter-example that has privatized tollways and public transportation.  She believes railways and the U.S. Postal Service also could be privatized. 

California’s slow broke

When questioned whether California would go broke, Whitney answered, “If they go broke, it’s going to take a really, really long time.”  She called California “the most dysfunctional political environment in the country.” The state will keep getting weaker and weaker each year until it has to start “selling down” assets.

Whitney was asked about population trends. “It’s incredible,” she said. “The first emigration or decline in population in California in 150 years.  What you see is high structural unemployment in states like California and the stalwarts of the last economy.”

The moment of truth for California and other states may come when the General Accounting Standards Board changes the rules next year to make it “apples to apples” when estimating unfunded pension liabilities, meaning public-sector pensions would be assessed according to standards already in place in the private sector.

Whitney predicted a big demographic shift in the next 30 years. People will ultimately move to where the jobs, cheap energy, and lower taxes are.  And that isn’t California.