LAO: Possible 2016 recession would devour budget surplus

LAO: Possible 2016 recession would devour budget surplus


length of u.s. recessionsThere is good news and bad news in the impartial California Legislative Analyst’s recent release of its “2014-2015 Budget: California’s Fiscal Outlook.”

The good news, “Stunning turnaround: California has budget surpluses as far as LAO can see.” That’s the San Jose Mercury News’ headline, but other news outlets featured similar optimism.  The LAO report forecasts a state budget surplus of $5.6 billion by mid-2015, with the happy days continuing for many years.

The bad news, as stated by the LAO:  an $8 billion budget reserve would be needed to weather a “hypothetical” economic recession beginning in 2016.  The LAO warns — but does not predict — that a cyclical economic recession could hit in 2016.

The history of U.S. recessions since World War II shows that they strike about every five years. (Click on the above chart to expand it.) The last one hit in December 2007, already six years ago.


In the detail of the LAO’s report, there is an $8 billion shortfall in the K-12 state education budget for 2014-15. If this hole were fully plugged, it would be unlikely that California could amass an $8 billion budget surplus to survive an economic recession in 2016.  In other words, California would be right back in the hole again with its protracted history of running budget deficits.

Then there is the $4.5 billion a year that the California State Teachers’ Retirement System claimed, in Dec. 2012, it needs to keep its system solvent. Gov. Jerry Brown did not included it in the fiscal 2013-14 budget he signed last June. But that, too, would wipe out most of the projected surplus.

Nor does the rosy part of the LAO projection address the growing expenditures on public health care programs, as reported by David Crane, former economic advisor to Gov. Arnold Schwarzenegger. Increasing health care costs are not a future liability, but a current budget expenditure that is occurring because of the the implementation of Covered California, our state’s version of Obamacare.

According to Crane, prisons, state employee salaries, bond interest payments, employee retirement costs and Department of Health Care costs are blowing a huge hole in California’s budget.

By the numbers

Here is the mixed numerical reality forecasted by the LAO in tabular form:


Percent change in:

2013 “Valley”

2016 “Peak”

2020 “Plateau”or
“High Plain”

Personal income Increase/year




Wage & salary employment Increase/year




Consumer Price Index Increase/year




Unemployment percentage of work force




Single & multi-family building permits




Gross Domestic Product – GDP increase/year




S&P stock market monthly average increase




Average target Federal Funds rate




Source: California Legislative Analyst, The 2014-2015 Budget: California’s Fiscal Outlook, Nov. 20, 2013, Figure 1.

The LAO forecasts a 45 percent decline in unemployment from 2013 to 2020. Yet a projected increase in interest rates by the U.S. Federal Reserve — which would boost mortgage rates — could mean slower growth. 


Another inconsistency in the LAO forecast is that it expects housing permits to increase from 88,000 per year in 2013 to 150,000 in 2016, leveling off at 162,000 per year in 2020.  This would reflect an 84 percent increase in housing permits per year, even as mortgage interest rates were, as noted, increasing by nearly 4 percentage points.

Yahoo Finance reports the current 30-year fixed mortgage rate is about 4.32 percent.  Thus, mortgage interest rates could climb to around the 8 percent range if the Federal Funds Rate is increased by 4.0 percentage points. 

The Federal Funds rate is the interest rate that the central bank charges to commercial banks.  The Federal funds rate is connected to mortgage rates. (This is explained in John F. McDonald and Houston H. Stokes’  “Monetary Policy, Mortgage Rates, and the Housing Bubble.”)

The LAO does not explain how a plausible doubling of mortgage interest rates would result in a near doubling of housing permits by 2020.

Everyone hopes that the LAO’s rosy prediction is the true one, so that at least the state could start addressing the “wall of debt.”

But the report does warn:

“Caution, therefore, is appropriate in weighing new spending both within Proposition 98 — as total funding for schools and community colleges would decline under this scenario — and on the non–Proposition 98 side of the budget. Absent a prudent reserve, the Legislature could well face during the next economic downturn some of the same difficult decisions that it was required to make during the past decade.”

Prop. 98 mandates that about 40 percent of general-fund revenues go to K-14 schools.

The bottom line, which was not emphasized nearly enough in media reports, is that there are no “budget surpluses as far as the LAO can see,” but somewhat better current numbers that could go negative again real fast.


Write a comment
  1. Queeg
    Queeg 26 November, 2013, 08:19

    This will blow Neanderthal minds.

    Should break thread posting records.

    Teddy and other pragmatics warm up.

    This gonna be a long long day!

    Reply this comment
  2. The Ted Steele Conceptual Abstraction Unit
    The Ted Steele Conceptual Abstraction Unit 26 November, 2013, 14:43

    Damn– the surplus good news only lived for 2 days– now were doomed again!

    Oh my—– it’s the end!!

    Reply this comment
  3. Rex the Wonderdog!
    Rex the Wonderdog! 26 November, 2013, 15:36

    $8 billion budget “surplus” while we have a $500 billion+ deficit.

    Awesome 🙂

    Reply this comment
  4. SeeSaw
    SeeSaw 26 November, 2013, 19:50

    Another recession is coming! I suppose the public sector is responsible for qualifying people for mortgages that they cannot pay.

    Reply this comment
  5. Hondo
    Hondo 26 November, 2013, 19:52

    We are due for a recession. With billions of dollars taken out of Americans hands by Obamacare’s increases, I’m sure even a small reset is coming. But it is Illinois that is going down first. Kali can raise taxes, but the business really don’t have any place to go nearby. Nevada isn’t an option.
    But Illinois is surounded by similar, close markets. Business there can run across the border to Indiana or Wisconsin and they have, taking their jobs with them, then sell their products back into that state. Illinois has a higher unemployment rate than Kali now and they are facing catastrophic budget problems. The state has 8 billion in short term bills they have no way of paying. Not counting 100 billion in pension problems. And with a new law there where the govts. there can’t defer to the future anymore payments into their pension funds, gigantic bills are coming due to the cities and the state in the next year. Any minor recession will bankrupt that state thereby maybe causing greater kaos across our economy.

    Reply this comment
  6. Rex the Wonderdog!
    Rex the Wonderdog! 30 November, 2013, 21:40

    The history of U.S. recessions since World War II shows that they strike about every five years. (Click on the above chart to expand it.) The last one hit in December 2007, already six years ago.

    Newsflash, we are still in the 2007 depression. Maybe not technically, but economically we are. We never recovered, and by “we” I mean poor and middle class America.

    Reply this comment
  7. Queeg
    Queeg 1 December, 2013, 08:38

    Wonder Pup:

    According to you Bunker Boys the sky falls daily…..enough already… could get really really scared. Whew!,,,,, zzzzzzzzzzz.

    Reply this comment
    • Rex the Wonderdog!
      Rex the Wonderdog! 1 December, 2013, 12:59

      According to you Bunker Boys the sky falls daily…..enough already… could get really really scared. Whew!

      Errrr….we have never recovered, that was my comment Teddy, deal w/it or put up your own comment.

      Reply this comment

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