Wednesday, November 12, 2008



Mac Taylor forecasts that the state will need to close a $27.8-billion budget gap in the next 20 months. He calls for a smaller sales tax increase than Gov. Schwarzenegger has suggested.

Overview of the 2008 Special Session Proposals

Webcast: Assessment of Special Session Proposals
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Overview of the 2008 Special Session Proposals
November 10, 2008
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“We concur with the administration’s assessment that the state’s struggling economy signals a major reduction in expected revenues. Combined with rising state expenses, we project that the state will need $27.8 billion in budget solutions over the next 20 months. The state’s revenue collapse is so dramatic and the underlying economic factors are so weak that we forecast huge budget shortfalls through 2013‑14 absent corrective action. From 2010‑11 through 2013‑14, we project annual shortfalls that are consistently in the range of $22 billion.”

By Jordan Rau – LA Times


November 12, 2008 — Reporting from Sacramento — While offering the grimmest forecast yet of California's finances, the Legislature's nonpartisan fiscal analyst recommended Tuesday that lawmakers pare back Gov. Arnold Schwarzenegger's proposed 1 1/2 -cent sales tax increase and instead hike fees on cars.

In a new report, Legislative Analyst Mac Taylor forecast that the state would need to close a $27.8-billion budget gap during the next 20 months. That projection is more than $3 billion higher than the Schwarzenegger administration has estimated.

"The numbers are just truly awful," Taylor told reporters. "There are no good options left."

The analyst's wider budget gap was influenced by the rapid decline in the state's housing market. He projected that school districts would lose $1.5 billion over the next three years, requiring the state to fill that gap.

The economic downturn also has led to more people on health and social services programs. In addition, firefighting costs are higher than projected.

The governor last week called a special session of the Legislature and proposed deep cuts in services and tax increases to deal with California's collapsing finances.

Though calling the governor's proposal "credible," the analyst said that raising the sales tax would further hurt the economy by discouraging Californians from buying products locally and instead shifting them to Internet purchases that escape the state sales tax.

Schwarzenegger's proposed increase would make California's sales tax, which varies from city to city, the highest in the nation, at an average of about 9.5%, the analyst said.

"That's not something you want to be No. 1 in," he said. Taylor recommended a smaller increase of 1 cent on the dollar.

The analyst favored increasing the annual vehicle license fee, from 0.65% of a car's value to 1%. It is an idea that has traction among Democratic lawmakers, but one that Schwarzenegger has resisted.

His opposition to that fee was a main plank of his 2003 election, and he reduced the fee, then 2%, as one of his first acts in office.

The governor instead has proposed charging people an additional flat fee of $12 more when they register their automobiles each year. That would bring in only about a 10th of the $1.6 billion in revenue that a vehicle license fee increase would net.

The analyst said that without major changes, the state would run shortfalls on the order of $22 billion annually over the next five years even if the economy rebounded.

Taylor offered some variations to the $10.6 billion in cuts to schools, healthcare, welfare and transit that Schwarzenegger has proposed, but he endorsed the governor's view that the severity of the budget gap requires both new revenue and program cuts.

"The magnitude of the problem has now reached such a level that we're not clear how you could do one side or the other," he said.

Shortly after Taylor spoke to reporters, Roger Niello (R-Fair Oaks), the ranking Republican on the Assembly budget committee, issued a statement saying, "We strongly disagree with the analyst's call for higher taxes."

Some GOP votes would be needed for the Democrat-led Legislature to pass any tax increase.

Meanwhile, Assembly Speaker Karen Bass (D-Los Angeles) on Tuesday urged the federal government to bail out states as well as banks.

"We think that with the state of California about to go over a cliff, we ought to be part of the bailout as well," she said at a news conference. "Can we have $5 billion or $10 billion?"

The analyst said that although California should press for federal assistance, lawmakers should not count on or wait for such relief, which he estimated would probably not be more than $3 billion.

"If the state has any hope of developing a fiscally responsible 2009-10 budget, it must begin acting now," Taylor wrote in his report.

Tuesday, November 11, 2008



The Times points out that the Car Tax/VLF served California well for 60 years. Undoing it has failed the state for six years. Until last year reimplementing it would have actually balanced (or come close to balancing) the budget. It's not enough anymore, but it's got to be on the table. Along with spitting the rolls on Prop 13 …but one sacred cow/third rail/taboo metaphor at a time.


Editorial from the Los Angeles Times

November 11, 2008 -- Gov. Arnold Schwarzenegger has shown he's capable of learning. Not every governor who rode into office on a no-new-taxes pledge would propose a sales-tax increase of 1.5%. He's right to insist that every solution to the state's fiscal crisis be on the table, so we're happy to pitch in with a suggestion -- bring back the car tax.

There, we said it. Again. California's leaders took a wrong turn in 1999 when they slashed the vehicle license fee, or car tax. The move frittered away a rare revenue surplus that should have been used instead to fix the state's structural deficit. The plan supposedly called for the rate to go back up during fiscal crises to the same level it had been since 1948 -- 2% of vehicle value. But when then-Gov. Gray Davis tried to do just that, Schwarzenegger fanned voter anger and booted Davis from office.

It's not out of a sense of mischief that we now call on Schwarzenegger to bring the tax back to its historical level. Not solely, anyway. The car tax is a smarter choice than a sales tax for digging out of the current budget hole. Asking Californians to pitch in through their vehicle registration fees rather than at the cash register would have fewer negative effects on sales, which we can expect to be diminished too much already in the coming months.

Sales taxes are regressive: They take a higher percentage of household income from the poor than from the rich. A 1999 California Policy Research Center study found vehicle license fees to be nearly as regressive, but at least the proceeds are unrestricted and could be used to bail the state out of its mess. Because of voter fiat, sales taxes paid at the gas pump are off limits for any use but transportation. Local government also claims a share. Another advantage of car taxes: They are deductible from federal income tax. Try deducting your sales tax on your 1040 form and see how far you get.

Schwarzenegger already has swallowed his pride a bit on car taxes: He's proposing that each vehicle owner pay $12 more. But that's an especially regressive fee, imposing barely an irritant on a wealthy motorist while packing a wallop for a low-income one. The state can do far better for itself and its residents by returning to the tried-and-true vehicle license fee.

Any tax hike will cause pain, but not nearly as much as the deepest budget cuts the governor is proposing. And sales taxes are already rising: If the 1.5% state increase is adopted, the rate in two Los Angeles County cities will be 11.25%, and just a penny less in the rest of the county. That's not the way to go. Cutting the car tax helped get us into this mess. Restoring it to the rate that served California for 60 years can help get us out.


Wells Fargo is state's chief beneficiary of change that allows banks to write off losses when taking over failing institutions.

By Evan Halper | From the Los Angeles Times

November 11, 2008 -- Reporting from Sacramento — Even as California's fiscal woes mount, the state is slated to lose an additional $2 billion in coming years as a result of new tax breaks the Bush administration created for a small group of banks including California-based Wells Fargo.

A tax change put into effect by the U.S. Treasury Department provides new federal and state breaks for banks that take over other failing financial institutions. The subsidies come on top of the $700 billion in bailout money that Congress authorized as part of the federal rescue plan.

The move is provoking anger among lawmakers and activists from Washington to Sacramento. The primary beneficiary here will be Wells Fargo, which acquired Wachovia Corp. days after the Bush administration changed the tax law.

"It is an affront to the state's taxpayers," said Lenny Goldberg, executive director of the nonprofit California Tax Reform Assn. "While struggling with a revenue crisis, we now have to contribute to the federal bank bailout."

At issue is the extent to which banks can write off losses they absorb when taking over other banks. Decades-old limits on those write-offs were removed by the Treasury Department on Sept. 30. An estimate by the law firm Jones Day, which represents banks, found that the change will save banks as much as $140 billion, mostly in federal tax relief.

Officials at the state Franchise Tax Board, California's tax collection agency, say state law requires them to conform with the new rule.

Days after the tax rule was changed, Wells Fargo successfully moved to acquire Wachovia Corp., whose losses on loans could reach more than $70 billion. Tax experts at Jones Day and elsewhere have projected that those losses will allow Wells Fargo to claim $20 billion to $25 billion in total tax breaks.

Officials at Wells Fargo declined to comment.

Experts say other banks will also benefit, but to a lesser extent. PNC Financial Services Group, which recently acquired National City Corp., could receive as much as $5 billion in tax savings, they say. Banco Santander, which took over Sovereign Bancorp, is expected to receive a smaller boost.

As other banks take over failing institutions in coming months and years, the tax breaks will be extended to them for losses absorbed.

Treasury spokesman Andrew DeSouza said the rule change was not intended to help any particular bank or to be part of the federal bailout package, which was being debated in Congress when the agency acted.

"This was something that was under development for many, many weeks," DeSouza said.

He declined to comment on the cost of the change to the federal and state governments, which he said the Treasury Department did not factor into its decision-making.

Most of the tax advantages will be claimed on federal returns. But state tax board figures obtained by The Times show California will take a $300-million hit this year. In subsequent years, that sum would gradually drop until the $2 billion in tax breaks is exhausted.

The subsidies come at a time when California is facing a severe budget shortfall.

"It's going to cost us $300 million when we need every penny," said Assembly Revenue and Taxation Committee Chairman Charles Calderon (D-Montebello).

It will be at least three years before the banks exhaust their tax breaks and the state collects that revenue again.

Late last week, Gov. Arnold Schwarzenegger called for billions of dollars in sales tax increases and new taxes on retail sales, services, oil companies and car registrations to help close a projected deficit of $24 billion through mid-2010.

The governor also called for billions of dollars in cuts to schools, healthcare, law enforcement and other state programs.

Education officials said the governor's plan would force them to shut down schools in the middle of the academic year.

Schwarzenegger administration officials and state lawmakers Monday were studying the possibility of passing legislation to eliminate the tax break in California.

State Sen. Darrell Steinberg (D-Sacramento), who will take over as leader of the upper house next month, said the Treasury's move created an "inappropriate loophole that will have a direct impact on us."

But changing California tax law to eliminate the subsidies could require a two-thirds majority of the Legislature, meaning that at least five Republicans would have to vote for it. Most GOP lawmakers have signed a pledge against raising taxes; elimination of the tax break could be seen as a breach of that pledge.

A spokeswoman for the Assembly's minority Republicans said staffers are still reviewing how the tax break applies to California.

In Washington, some lawmakers are asking whether the tax break is necessary.

U.S. Sen. Charles E. Schumer (D-N.Y.) recently sent a letter to Treasury Secretary Henry Paulson expressing concern about tens of billions of dollars in subsidies being created without Congress having any say.

Schumer said the new tax rule threatens to undermine competition in the financial industry by motivating banks to buy other banks just to create tax shelters for themselves

DeSouza said the Treasury Department is working on a response to Schumer's letter.


The Wall Street titan's activities could have harmed taxpayers, officials say

By Sharona Coutts, Marc Lifsher and Michael A. Hiltzik From the Los Angeles Times

November 11, 2008 -- Goldman, Sachs & Co. urged some of its big clients to place investment bets against California bonds this year despite having collected millions of dollars in fees to help the state sell some of those same bonds.

The giant investment firm did not inform the office of California Treasurer Bill Lockyer that it was proposing a way for investment clients to profit from California's deepening financial misery. In Sacramento, officials said they were concerned that Goldman's strategy could raise the interest rate the state would have to pay to borrow money, thus harming taxpayers.

"It could exaggerate people's worries about our credit," said Paul Rosenstiel, head of the public finance division of the treasurer's office.

Such worries would tend to drive down the price of California bonds. That, in turn, would drive up the interest rate the state and its municipalities pay to borrow money. An increase of a single percentage point on a $1-billion bond issue would cost taxpayers an additional $10 million a year in interest.

That's especially troublesome at a time of severe budget turmoil and tight credit. Gov. Arnold Schwarzenegger has warned that the state could run out of cash as early as February.

Some experts said the investment bank's actions, while not illegal, might be inappropriate. "That's not a good way to do business," said Geoffrey M. Heal, professor of public policy and business responsibility at Columbia University. "They've got a conflict of interest and they're acting against the interest of their customers. . . . You act in the interests of your clients. You don't screw them, to put it bluntly."

Goldman declined to discuss the details of its trading strategy. "We continue to support our clients and underwrite transactions," spokesman Michael DuVally said in an e-mail response to written questions on Oct. 28. He said Goldman "as a firm" was no longer giving the trading advice to clients. He declined to elaborate.

Goldman's strategy was embodied in a 58-page report presented to institutional investors in September. The document, stamped "Proprietary and Confidential," was obtained by ProPublica, a New York-based nonprofit organization specializing in investigative reporting. This article was reported jointly by ProPublica and the Los Angeles Times.

Goldman stood to profit from several aspects of California's borrowing, which involves the sale of bonds to investors. First, it collected millions of dollars in fees for bringing the bonds to market and finding buyers. Then it marketed a financial instrument known as a credit default swap that is essentially an insurance policy against a bond default.

The bond investor buying the instrument pays a fee in exchange for a promise of a full refund of the bond's face value should a state such as California abruptly refuse to pay back what it owes. Such defaults are extremely rare -- California, for example, has never defaulted -- but the swaps' prices rise as states or municipalities slide into tough times economically.

Goldman, according to sources familiar with municipal bond trading, has been a leading dealer in municipal credit default swaps. The New York-based firm was trying to expand that niche market into one with broader appeal to major investors.

The company also is an important underwriter of California municipal securities. Over the last five years, it has earned about $25 million in underwriting fees from California issues.

The 58-page document advised big investors how they could profit from -- or hedge against losses in -- financial markets that had become extremely volatile and unpredictable. The firm advised "shorting" -- that is, betting on a price decline -- in markets for corporate junk bonds, European banks, the euro and British pound currencies, and U.S. municipal bonds.

Several large states, including California, faced "worsening fiscal outlooks," the report said. It cited the recent bankruptcy of the Bay Area city of Vallejo as evidence of the "worsening fundamentals of municipal finances."

Meanwhile, muni bond insurers were suffering credit downgrades, it noted, which undermined the quality, and therefore the prices, of the bonds they had insured. And the credit crunch was forcing big investors such as hedge funds to dump their muni bond portfolios, driving down the bonds' prices.

Goldman recommended making the short bets via credit default swaps, a market in which it played a major role.

These instruments are designed to allow investors and speculators to hedge, or insure against, the risk that bond issuers or other debtors might default on their obligations. In their customary form, they are contracts that require their sellers -- in this case Goldman Sachs -- to buy back from a swap holder a defaulted bond at 100 cents on the dollar, thus insuring against any loss.

In that way, the swaps could be beneficial to the market, encouraging risk-averse investors to buy more municipal bonds. But like derivative securities in general, they can be dangerous to hold. That's because they are often highly leveraged. A small investment can buy coverage on bonds worth much more. If defaults rise to unexpected levels, the swap sellers could be hard-pressed to make good on their promises.

The perils of the credit default swap market were brought home this year, when they were instrumental in the collapse of Lehman Bros. Holdings, American International Group and Bear Stearns. Lehman and AIG were rumored to owe far more than they could pay on swaps they had sold. Meanwhile, the prices of default swaps on the three firms soared, signaling to investors that the firms might be in trouble. Investigations continue into whether those swaps may have been manipulated to undermine confidence in the firms and drive them out of business.

"By encouraging people to buy swaps, you're pushing up the price of those and making it more expensive to insure against the default on the bond that you're buying," Heal said. "The fact that such coverage has gone up in price will signal to the investor that the riskiness of the bond has increased, even if that's not true. Even if the underlying financial situation of the state has not, in fact, changed."

Indeed, what some traders found perplexing about the push for a market in municipal credit default swaps was that muni defaults almost never happen.

Goldman was a leader in the effort to build up the market for the muni swaps. In May, when the financial information firm Markit introduced a municipal CDS index to give swap traders a benchmark to set prices, Goldman was listed as one of the seven dealers participating in the rollout.

For some time before that, Lockyer told The Times, Goldman had "regularly urged" California to trade in the municipal swaps itself, ostensibly to hedge the state's risks as a bond issuer. Lockyer refused.

The trading strategy that Goldman pitched to institutional investors was apparently crafted in the spring and summer. The company may have hoped to parlay the swaps market into more activity in municipal bond trading, which is traditionally light because muni investors tend to hold the bonds to maturity.

Theoretically, the swaps index could lure speculators into the muni market, a development that would create much more fluctuation in daily prices, which in turn would generate revenue for trading desks at Goldman and other investment firms.

Lockyer and Rosenstiel said they became aware of the introduction of the muni swaps index but had not detected an effect on trading or pricing of California bonds.

But they also said the market was so complex, and the conditions affecting municipal bond prices so numerous, that it might be difficult to identify any specific cause for a given price change in California debt issues.

"The existence of the credit default swap market in muni bonds has the potential to hurt muni issuers," Rosenstiel said, "but it also has the potential to help muni issuers, and I don't think we have enough experience to know which is which."

He acknowledged that it was not unusual for a full-service investment firm such as Goldman Sachs to have to navigate among potential conflicts of interest.

"Investment banks bring issuers and investors together," he said. "Securities law has recognized the potential for a conflict of interest in playing both roles."

Under the law, the solution is for the parts of the firm dealing with either side to be isolated from each other so that information does not improperly flow between them to benefit one set of clients more than another. There is no evidence that the wall was breached in this case. Assuming such protection was in place, Lockyer said that fear of market manipulation was unfounded.

Still, Heal said he was surprised by Goldman's actions. "Goldman Sachs has a reputation as behaving in a responsible manner . . . and I don't think this is consistent with their traditions," he said.

"States are going to have to cut back on education, social services, a whole range of things because of the lack of credit. This is not just a Wall Street thing. This is going to affect the lives of less affluent people in the states that are affected."

In any case, there are signs that the muni swap index has been a bust. Tom Graff, managing director of Baltimore-based Cavanaugh Capital Management, said that by the end of August the index had failed to attract much business. It was destined "for oblivion," he said, in part because muni defaults were so rare.

Coutts, a writer with ProPublica, reported from New York. Lifsher, a Times staff writer, reported from Sacramento, and staff writer Hiltzik reported from Los Angeles.

Monday, November 10, 2008


The governor has proposed some ugly spending cuts.

  • He calls for slashing education by $2.5 billion in mid-school year.
  • He wants to significantly pare grants for the aged, blind and disabled, plus welfare moms.
  • He'd eliminate such Medi-Cal services as adult dental care, hearing aids, speech therapy, vision care and podiatry.

George Skelton | Capitol Journal | From the Los Angeles Times

November 10, 2008 -- Reporting from Sacramento — He finally said it. I saw him. Heard his words.

Gov. Arnold Schwarzenegger acknowledged that Sacramento's problem is not overspending. The problem is that the state isn't collecting enough taxes.

"When we talk about living within our means," the governor told a Capitol news conference last week, "we say, many times, that we have a spending problem, not a revenue problem. It just has happened this year that it actually has switched. . . .

"It is now a revenue problem rather than a spending problem, because our spending in this state has not increased now for years. We have been very steady and we have been very fiscally responsible. . . . It's just that the revenues have dropped so rapidly."


Schwarzenegger began this year reciting the simplistic "spending problem" mantra chanted by fellow Republicans. He's ending it sounding like a realist, if not a Democrat.

Actually, Sacramento has been suffering a revenue problem for a long time, at least since the first day Schwarzenegger took office in 2003 and immediately dug the state deeper into recalled Gov. Gray Davis' deficit hole.

The showboating Schwarzenegger had campaigned gleefully against Democrat Davis' raising of the vehicle license fee -- the so-called car tax -- and had even used a wrecking ball to smash an old jalopy in one stunt. It was great TV. "Outrageous," Schwarzenegger called the tax.

So in his first act as governor, Schwarzenegger sharply whacked the license fee. The budget still hasn't healed.

All the fee's revenue had gone to local governments. Schwarzenegger generously agreed to "backfill" their loss out of the state general fund. And five years later, that fee cut amounts to a $6-billion annual state spending program.

Schwarzenegger initially covered the cost and "balanced" the budget by talking voters into borrowing $15 billion. All that money is gone and we're still paying off the loan.

Last week, while calling a special legislative session, the governor projected red ink for the current fiscal year at $11.2 billion. Without a fix, there'll be an additional $13 billion the next fiscal year.

As a first step, he proposed $4.7 billion in tax hikes and $4.5 billion in spending cuts -- on top of the nearly $11.4 billion in reductions already part of the current budget, according to administration figures.

Credit Schwarzenegger with at last facing the problem: a severe revenue shortage.

The long-range solution is to modernize the antiquated tax code that relies too heavily on retail sales and also leans too much on the fortunes of rich people. When their stock portfolios and capital gains earnings tank, so do Sacramento's tax revenues.

The governor and Assembly Speaker Karen Bass (D-Los Angeles) are creating a commission to recommend a major tax restructuring.

Meanwhile, Schwarzenegger last week jumped ahead of the commission by recommending a landmark extension of the sales tax to some services: vehicle, furniture and appliance repairs; veterinarian care; amusement parks, sporting events and golf rounds.

There'll be no taxing of movie tickets by the former screen hero, however.

The governor also proposed an oil severance tax -- a tax on virtually every barrel pumped from the ground or ocean in California. We're the only major oil-producing state without such a tax.

But another logical tax causes Schwarzenegger to turn white whenever it's mentioned. That's his old campaign foil, the vehicle license fee.

"That would hurt the economy too much," he told reporters when asked about it. "We have a severe drop in [sales of] cars right now . . . and the car companies and everyone are really hurting. . . . I don't think that we should go there."

But if the governor was all that worried about car sales, he wouldn't be proposing a sales-tax increase of 1 1/2 cents on the dollar. It would add $450 to the cost of a $30,000 vehicle.

That steep a sales-tax hike, even if temporary as he proposes, seems a bit much. A simple penny-on-the-dollar bump might go down better.

It's all moot, however, as long as Republican legislators rigidly refuse to even discuss a possible tax increase. At least a few Republican votes will be needed to obtain the required two-thirds majority.

The two GOP leaders -- Sen. Dave Cogdill of Modesto and Assemblyman Mike Villines of Clovis -- issued a joint statement declaring that they were "very disappointed" in the governor. Nothing new there. They added: "Raising taxes is the worst thing we could do right now. It will devastate an economy that is hanging on a thread. . . .

"Instead of raising taxes so the Legislature can spend even more on bigger government, Republicans believe that our priority in the special session should be putting California jobs first and encouraging more companies to invest in our state."

Call me Pollyanna, but I see a faint ray of potential compromise there. It's conceivable some Republicans could be lured into supporting tax hikes in exchange for business-friendly legislation, such as allowing more flexible work rules and streamlining environmental regulation, as the governor has suggested.

The pot could be sweetened by authorizing the sale of surplus state property and allowing offshore oil drilling from existing platforms. Both could be moneymakers.

The Democrats' special-interest constituencies -- labor and environmentalists -- would find things to fight about. But there's no faction, on the left or right, that's going to like what the governor and Legislature ultimately agree to -- if, indeed, they're capable.

The governor also proposed some ugly spending cuts. He called for slashing education by $2.5 billion in mid-school year. He wants to significantly pare grants for the aged, blind and disabled, plus welfare moms. He'd eliminate such Medi-Cal services as adult dental care, hearing aids, speech therapy, vision care and podiatry.

Schwarzenegger badly needs to do two things: Coerce, cajole or bribe a few Republicans into voting for a tax increase. And swallow his pride and raise the car tax at least halfway back to where it was. He could pick up $3 billion and still claim a net cut under his regime.

Everybody needs to give a little. No, a lot.

A bigger problem -- even than revenue -- is a shortage of pragmatism.

Thursday, November 6, 2008


SacBee CapAlert | Steve Wiegand | November 6, 2008

With California facing a $11.2 billion shortfall in the current year and another $13 billion next year, Gov. Arnold Schwarzenegger has proposed a mixture of tax hikes, spending cuts and state worker furloughs to help balance the books.

Steve Wiegand has an overview of the plan.

Here is the full list of new revenues Schwarzenegger wants to bring in:

Temporary sales hike: Effective Jan. 1, 2009, Schwarzenegger would raise the state sales tax by 1.5 percent for three years, from 5 percent to 5.6 percent. At the end of three years, the rate would return to 5 percent.

Over the summer, the governor proposed a temporary 1-cent sales tax hike followed by a .25 cent cut - but Republicans rejected the proposal.

What it would bring in: $3.54 billion 2008-09 and $7.3 billion in 2009-10

Add tax to services: Effective Feb. 1, 2009, Schwarzenegger would begin taxing certain services that are currently untaxed at the new 6.5 percent sales tax rate. Those include appliance repair, furniture repair, vehicle repair, golf and veterinarian services.

As of March 1, Schwarzenegger would tax amusement park and sports evenings. Unlike the sales tax rate increase, the broadening to services appear to be permanent.

What it would bring in: $357 million in 2008-09 and $1.15 billion in 2009-10.

Oil severance tax: Effective Jan. 1, 2009 Schwarzenegger would tax oil extracted from the ground or water in California at a rate of 9.9 percent of the gross value.

What it would bring in: $528 million in 2008-09 and $1.195 billion in 2009-10

Nickel-a-drink tax: Effective Jan. 1, 2009 Schwarzenegger would hike the alcohol taxes in the stat by a nickel per drink (defined as 1.5 ounces of liquor, 12 ounces of beer, or 5 ounces of wine)

What it would bring in: $293 million in 208-09 and $584 million in 2009-10.

Vehicle registration fee: Effective Feb. 1, 2009, Schwarzenegger would raise vehicle registration fees by $12.

What it would bring in: $150 million in 2008-09 and $359 million in 2009-10.


By Michael B. Marois –

Enlarge Image/Details

November 6, 2008 16:08 EST (Bloomberg) -- California Governor Arnold Schwarzenegger said his state's finances have deteriorated so rapidly that a budget he signed just six weeks ago has already fallen into a $11.2 billion deficit and taxes must be raised.

Schwarzenegger ordered lawmakers into a special session to consider ways to close the gap. He proposed increasing the sales tax by 1.5 percentage points for three years as well as raising oil severance and alcoholic beverage taxes and motor vehicle fees. In all, taxes and fees would increase $4.7 billion while spending is cut $4.5 billion.

``We have a dramatic situation here and it will take dramatic solutions to solve it,'' Schwarzenegger, a 61-year-old Republican, told reporters in Sacramento. ``We must stop the bleeding.''

California has been hard hit by the housing-market rout and the worst financial crisis on Wall Street since the Great Depression. The state leads the nation in foreclosures and its unemployment rate reached 7.7 percent last month, the fourth highest in the country. Double-digit declines in stock markets have sapped tax revenue from income and capital gains.

Schwarzenegger said this shortfall differs from those in years past, when he resisted tax increases to solve what he said were problems caused by overspending. ``It is now a revenue problem, rather than a spending problem,'' he said.

The Standard & Poor's 500, down 39 percent in 2008, slumped 19 percent in October alone. The Dow Jones Industrial Average dropped 35 percent this year. The declines have erased more than $9.5 trillion from the value of stocks worldwide.

Proposed Cuts

Schwarzenegger's proposal also would expand sales and use taxes to include appliance and furniture repair, vehicle repairs, golf greens' fees, amusement park admissions, sporting event tickets and veterinarian services.

Statewide sales taxes would increase to 8.75 percent from 7.25 for three years. The proposal would add a 9.9 percent per barrel severance tax on oil drilled in this state. The proposal would also add 5 cents for every alcoholic mixed-drink, beer and glass of wine sold in the state.

He warned that if lawmakers don't take action soon, the state would run out of money in February and might be unable to pay some bills, including payroll.

The budget gap has grown from $3 billion the state estimated when it sold $5 billion of short-term notes Oct. 16. That deficit figure was based on tax revenue projections through September and didn't anticipate projected shortfalls in October.

Notes Shelved

The state was supposed to sell another $2 billion of notes this month. That sale has now been shelved, budget director Mike Genest said.

``Now with the announcement of this size of a deficit, I can't imagine us being able to borrow until the Legislature gives us the solutions we need to get back on an even keel,'' Genest said.

California Treasurer Bill Lockyer said he will postpone any bond offering backed by the state's general fund until lawmakers agree on how to solve the problem.

``Current financial market conditions are not favorable, and with our state budget assumptions in flux during the special session, securities disclosure requirements would make it difficult or impossible to access the credit market,'' Lockyer said in a statement. ``Investors will want to see how the state addresses the budget imbalance before lending to us at reasonable rates.''

Lame Ducks

By ordering a special session now, Schwarzenegger is gambling that Republican lawmakers who are stepping down because of term limits or who were defeated during the Nov. 4 general election might be willing to approve the tax increase before a new class of lawmakers takes office on Dec. 1.

California requires a two-thirds legislative majority to raise taxes, a requirement that has hobbled proposals to increase revenue because of steadfast resistance from Republican lawmakers. Schwarzenegger said he was optimistic that fellow members of his party would see the need to boost taxes, given the slumping stock market and economic slowdown.

``No one wants to raise taxes, but we have an obligation to fully fund public education and to fund infrastructure and to make progress in health care,'' said Senate President pro Tem- Elect Darrell Steinberg, who will take over the leadership job Dec. 1.

Foreclosures Help

Schwarzenegger today also proposed a 90-day stay on home foreclosures to help distressed homeowners and stem escalating defaults. Under the measure, lenders would be exempt from the stay if they can prove they have set up a program to help troubled homeowners modify their loans.

The number of California homes in foreclosure totaled 79,511 in the third quarter, said San Diego-based real estate research firm MDA DataQuick. That was more than triple the year- earlier number, and the highest since MDA DataQuick began tracking trustee deeds in 1988.

Schwarzenegger signed a $143 billion budget Sept. 23, a record 85 days past the start of the fiscal year, following a standoff with lawmakers over how to close a $15 billion deficit caused when the housing-market rout erased thousands of jobs and weighed on residents' incomes. Democrats wanted to raise taxes, which Republicans opposed.

Corporate Taxes

Lawmakers ultimately agreed to cut $8 billion in spending, doubling penalties charged to companies that underestimate taxes owed the state, suspending the net operating loss deduction companies can claim when they don't report a profit and temporarily cutting in half the tax credit for research and development.

California, the biggest borrower in the municipal-bond market, has $51.9 billion in general-obligation debt outstanding. The state is rated A+ by Fitch Ratings and Standard & Poor's, the fifth-highest rankings, and a comparable A1 by Moody's Investors Service.


by smf for LAKids from articles in the LA Times, the FATR website and wire services reports

California lawmakers are heading back to work in Sacramento to address a state budget that is projected to go as much as $25 billion into the red.

In the midst of this, Gov. Schwarzenegger will seek to push through over $100 million in tax credits for film industry companies that do business in state during the budget-focused special session. Schwarzenegger and film industry officials claim the credits are needed to keep California a competitive location for such activity.
FRIENDS OF AMERICAN TAX REFORM – a group that apparently shares Sarah Palin’s belief that paying taxes is not a patriotic duity - seems to at least philosophically supportive of this ….but question:

California is the biggest borrower in the municipal-bond market and has $51.9 billion in general-obligation debt outstanding. Because California is so dependent on bonds and credit financing - the state budget mess directly contributes to the international credit mess.

The governor is expected to unveil the proposal this week, after the Legislature opens a special session to address the state's fiscal crisis. Schwarzenegger’s proposal, part of his plan to stimulate the state economy, is similar to his previous bids for such a tax break - rejected in the past.

  • The tax concessions would probably cost the state at least $100 million a year.
  • They are being proposed at a time when the state budget is $10 billion in the red, less than halfway into the fiscal year.
  • The tax cut could be overshadowed by billions of dollars in sales tax hikes the governor has told education officials he wants lawmakers to approve.

Administration officials say the cut is necessary to stop the industry's migration out of state. As an example, they cite the recent departure of Disney's hit television series "Ugly Betty," which relocated to New York.

Five years ago, 66% of all feature film production took place in California. Last year, the state claimed just 31%. About 250,000 Californians work in the industry.

The governor's proposal tries to address the critics' concerns by extending the tax breaks only to new shows and those relocating to California from elsewhere. Productions already in California and unlikely to move elsewhere would not qualify.

Lenny Goldberg, executive director of the nonprofit California Tax Reform Assn. in Sacramento. suspects that companies the tax break is not intended to help would find ways to take advantage of it. Goldberg also is troubled by the way the credits would be structured. Even companies that pay no state taxes could cash in.

"We're sort of skeptical of this happening because so many times it's been dangled out there, and so many times it's disappeared," said Barry Broad, a Sacramento lobbyist for the International Brotherhood of Teamsters, which represents thousands of film industry workers. Broad also questioned the timing of the bid. He said his union did not support the tax break if paying for it would require more deep cuts in government services.

But filmmakers say the state's dismal finances should bring more urgency -- not less -- to the proposal.

"Desperate times call for desperate measures," said Stanley Brooks, president of Once Upon a Time Films in Santa Monica and chairman of the California Film Commission. He is an appointee of the governor.

Brooks, whose company produces television movies and miniseries, said the tax credits would boost local production, creating jobs that would bolster the state economy.

The GOP lawmakers who typically line up behind tax breaks have been wary of the governor's concept in the past. The tax concessions would aid an industry dominated by deep-pocketed Democratic political contributors.

And Republicans have questioned whether they would create the jobs that Schwarzenegger and other backers promised.

The Republicans in the legislature continue to pound the drum for "No New Taxes"; against that wall of sound it becomes easy to call for “No New Tax Breaks!”


Sacramento Bee | CapitolAlert | November 6, 2008

The results aren't finalized yet, but we want to know who you think are this fall's biggest election winners and losers.

In case you missed it yesterday, here are the California ballot measure, legislative candidate and congressional candidate results.

Believe it or not, the election is only two days behind us, but the special session on the bleeding state budget is already here.

Gov. Arnold Schwarzenegger is expected to call for the session today. He's also expected to release the most up-to-date estimates of the size of the deficit and present his solutions. (Think of it as the November Revision, which followed the August Revision, which followed the May Revision, which followed the January budget unveiling.)

Senate leader Don Perata let the cat out of the bag Wednesday about the size of the deficit: $11.2 billion this year, followed by $13 billion next year.

Perata and incoming Senate leader Darrell Steinberg called for new taxes -- specifically hiking the vehicle license fee (better known as the car tax) and implementing an oil severance tax.

Assembly Republican leader Mike Villines said taxes are off the table for GOP lawmakers.

Villines, like caucus member Todd Spitzer, didn't hold out much hope for the special session.

"Elections tend to harden people's positions," the Clovis Republican said. "I think it's pretty difficult for people to come together and say kumbaya over the next three weeks."

Democrats and Republicans alike spent millions attacking each other in the run-up to the legislative elections.

"Right now, the wounds are on the top of the skin," Villines said.

Democrats, meanwhile, seem to be holding out hope that Schwarzenegger can sway some of his fellow party members to their new-revenues side of the aisle. That strategy did not work over the summer, as Republicans held out during a record-long budget standoff.

"It is a top priority to have (new) revenue in it," said Assembly Speaker Karen Bass.

"Since the governor is calling the special session ... I am assuming then that he is bringing some votes to the table," Bass added.

Sunday, November 2, 2008



    Wooed by bankers, Wisconsin schools and New York subways are among the many players in a financial fiasco that has ricocheted globally.


NPR Audio: Coach in Kenosha Feels Sting of Investment Gone Bad


The New York Times





Ashley Gilbertson for The New York Times

IN WISCONSIN “This is something I’ll regret until the day I die,” said Shawn Yde of the Whitefish Bay schools.

School board member Mark Hujik. Credit: Ashley Gilbertson NYT/NPR

Ashley Gilbertson/NPR/New York Times


   “Unfortunately what we thought we bought and what we bought . . . weren't necessarily reality or the truth.”


     “People come up to me in the grocery store and say, ‘How did we get suckered into this?’ ”

—  School board member Mark Hujik, owner of an asset management firm and football coach in Kenosha, Wis.


November 2, 2008 - On a snowy day two years ago, the school board in Whitefish Bay, Wis., gathered to discuss a looming problem: how to plug a gaping hole in the teachers’ retirement plan.

It turned to David W. Noack, a trusted local investment banker, who proposed that the district borrow from overseas and use the money for a complex investment that offered big profits.

“Every three months you’re going to get a payment,” he promised, according to a tape of the meeting. But would it be risky? “There would need to be 15 Enrons” for the district to lose money, he said.

The board and four other nearby districts ultimately invested $200 million in the deal, most of it borrowed from an Irish bank. Without realizing it, the schools were imitating hedge funds.

Half a continent away, New York subway officials were also being wooed by bankers. Officials were told that just as home buyers had embraced adjustable-rate loans, New York could save money by borrowing at lower interest rates that changed every day.

For some of the deals, the officials were encouraged to rely on the same Irish bank as the Wisconsin schools.

During the go-go investing years, school districts, transit agencies and other government entities were quick to jump into the global economy, hoping for fast gains to cover growing pension costs and budgets without raising taxes. Deals were arranged by armies of persuasive financiers who received big paydays.

But now, hundreds of cities and government agencies are facing economic turmoil. Far from being isolated examples, the Wisconsin schools and New York’s transportation system are among the many players in a financial fiasco that has ricocheted globally.

The Wisconsin schools are on the brink of losing their money, confronting educators with possible budget cuts. Interest rates for New York’s subways are skyrocketing and contributing to budget woes that have transportation officials considering higher fares and delaying long-planned track repairs.

And the bank at the center of the saga, named Depfa, is now in trouble, threatening the stability of its parent company in Munich and forcing German officials to intervene with a multibillion-dollar bailout to stop a chain reaction that could freeze Germany’s economic system.

“I am really worried,” said Becky Velvikis, a first-grade teacher at Grewenow Elementary in Kenosha, Wis., one of the districts that invested in Mr. Noack’s deal. “If millions of dollars are gone, what happens to my retirement? Or the construction paper and pencils and supplies we need to teach?”

The trail through Wisconsin, New York and Europe illustrates how this financial crisis has moved around the world so fast, why it is so hard to tame, and why cities, schools and many other institutions will probably struggle for years.

“The local papers and radio shows call us idiots, and now when I go home, my kids ask me, ‘Dad, did you do something wrong?’ ” said Shawn Yde, the director of business services in the Whitefish Bay district. “This is something I’ll regret until the day I die.”

Selling Risk

Whitefish Bay’s school district did not intend to become a hedge fund. It and four nearby districts were just trying to finance retirement obligations that were growing as health care costs rose.

Mr. Noack, the local representative of Stifel, Nicolaus & Company, a St. Louis investment bank, had been advising Wisconsin school boards for two decades, helping them borrow for new gymnasiums and classrooms. His father had taught at an area high school for 47 years. All six of his children attended Milwaukee schools.

Mr. Noack told the Whitefish Bay board that investing in the global economy carried few risks, according to the tape.

“What’s the best investment? It’s called a collateralized debt obligation,” or a C.D.O., Mr. Noack said. He described it as a collection of bonds from 105 of the most reputable companies that would pay the school board a small return every quarter.

“We’re being very conservative,” Mr. Noack told the board, composed of lawyers, salesmen and a homemaker who lived in the affluent Milwaukee suburb.

Soon, Whitefish Bay and the four other districts borrowed $165 million from Depfa and contributed $35 million of their own money to purchase three C.D.O.’s sold by the Royal Bank of Canada, which had a relationship with Mr. Noack’s company.

But Mr. Noack’s explanation of a C.D.O. was very wrong. Mr. Noack, who through his lawyer declined to comment, had attended only a two-hour training session on C.D.O.’s, he told a friend.

The schools’ $200 million was actually used as collateral for a complicated form of insurance guaranteeing about $20 billion of corporate bonds. That investment — known as a synthetic C.D.O. — committed the boards to paying off other bondholders if corporations failed to honor their debts.

If just 6 percent of the bonds insured went bad, the Wisconsin educators could lose all their money. If none of the bonds defaulted, the schools would receive about $1.8 million a year after paying off their own debt. By comparison, the C.D.O.’s offered only a modestly better return than a $35 million investment in ultra-safe Treasury bonds, which would have paid about $1.5 million a year, with virtually no risk.

The boards, as part of their deal, received thick packets of documents.

“I’ve never read the prospectus,” said Marc Hujik, a local financial adviser and a member of the Kenosha school board who spent 13 years on Wall Street. “We had all our questions answered satisfactorily by Dave Noack, so I wasn’t worried.”

Wisconsin schools were not the only ones to jump into such complicated financial products. More than $1.2 trillion of C.D.O.’s have been sold to buyers of all kinds since 2005 — including many cities and government agencies — an increase of 270 percent from the four previous years combined, according to Thomson Reuters.

“Selling these products to municipalities was pretty widespread,” said Janet Tavakoli, a finance industry consultant in Chicago. “They tend to be less sophisticated. So bankers sell them products stuffed with junk.”

From the Wisconsin deal, the Royal Bank of Canada received promises of payments totaling about $11.2 million, according to documents. Stifel Nicolaus made about $1.2 million. Mr. Noack’s total salary was about $300,000 a year, according to someone with knowledge of his finances. And Depfa received interest on its loans.

In separate statements, the Royal Bank of Canada and Stifel Nicolaus said board members signed documents indicating they understood the investments’ risks. Both companies said they were not financial advisers to the boards but merely sold them products or services. Stifel Nicolaus said its relationship with the boards ended in 2007. Mr. Noack now works for a rival firm.

“Everyone knew New York guys were making tons of money on these kinds of deals,” said Mr. Hujik, of the school board. “It wasn’t implausible that we could make money, too.”

A Bank Goes Global

By the time Depfa financed the Wisconsin schools’ investment, it had already become an emblem of the new global economy. It was founded 86 years ago as a sleepy German lender, and for most of its history had focused on its home market.

But in 2002 a new chief executive, Gerhard Bruckermann, moved Depfa to the freewheeling financial center of Dublin to take advantage of low corporate taxes. He soon pushed the company into São Paulo, Mumbai, Warsaw, Hong Kong, Dallas, New York, Tokyo and elsewhere. Depfa became one of Europe’s most profitable banks and was famous for lavish events and large paychecks. In 2006, top executives took home the equivalent of $33 million at today’s exchange rates.

Mr. Bruckermann was a gregarious leader who joked that he hoped to make all employees into millionaires. He divided his time between a London home and a vast farm in Spain, where he grew exotic medicinal plants. And his success fueled an arrogance, former colleagues say.

Mr. Bruckermann once told a trade publication that Depfa, unlike German banks, understood how to benefit from the global economy. “With our efforts, we are like the one-eyed man who becomes king in the land of the blind,” he was quoted as saying.

Mr. Bruckermann, who left the bank earlier this year, did not respond to requests for an interview.

But as Depfa grew, other European banks began competing with the firm. So executives stretched into riskier deals — the sort that would eventually send shockwaves across Europe and the United States.

Some of Mr. Bruckermann’s employees grew concerned about deals like one struck in 2005 with the Metropolitan Transportation Authority of New York, the agency overseeing the city and suburban subways, buses and trains.

For years, municipal agencies like the M.T.A. had raised money by issuing plain-vanilla bonds with fixed interest rates. But then bankers began telling officials that there was a way to get cheaper financing.

Bankers said that cities, like home buyers, could save money with adjustable-rate loans, where the payments started low and changed over time. What they did not emphasize was that such payments could eventually skyrocket. Such borrowing — known as variable-rate bonds — also carried big fees for Wall Street.

The pitches were very successful. Municipalities issued twice as many variable-rate bonds last year as they did a decade earlier.

But variable-rate bonds had a hitch: many investors would purchase them only if a bank like Depfa was hired as a buyer of last resort, ready to acquire bonds from investors who could find no other buyers. Depfa collected fees for serving that role, but expected it would rarely have to honor such pledges.

Mr. Bruckermann’s salespeople traveled the world encouraging officials to sign up for variable-rate loans. And bureaucrats and politicians, including some in New York, jumped in.

By 2006 Depfa was the largest buyer of last resort in the world, standing behind $2.9 billion of bonds issued that year alone. It backed a $200 million bond issued by the M.T.A.

But as Depfa grew, it became more reliant on enormous short-term loans to finance its operations. Those loans cost less, and thus helped the bank achieve higher profits, but only when times were good. Indeed, some employees were worried about that debt.

But Mr. Bruckermann plowed ahead, and it paid off. In 2007, even as the global economy was softening, Mr. Bruckermann persuaded one of Germany’s biggest lenders, Hypo Real Estate, to purchase Depfa for $7.8 billion. Mr. Bruckermann’s cut was more than $150 million. He left the company to grow oranges on his Spanish estate.

The Risks Turn Bad

Last March the delicate web tying Wisconsin, Dublin and Manhattan became an anchor dragging everyone down.

Mr. Yde, the director of business services for the Whitefish Bay district, began receiving troubling messages indicating the district’s investments were declining. Worried, he started coming into his office at dawn, before the hallways of Whitefish Bay High School filled with students.

As the sun rose, Mr. Yde searched for explanations by the light of his computer screen. He Googled “C.D.O.’s.” He called bankers in London and New York. Each person referred him to someone else.

Then notices arrived saying that the bonds insured by Whitefish Bay’s C.D.O.’s were defaulting. It became increasingly likely that the district’s money would be seized to pay off other bondholders. Most, if not all, of the $200 million would probably be lost.

As other districts received similar notices, panic grew. For some boards, interest payments on borrowed money were now larger than revenue from the investments. Officials began quietly warning that they might have to dip into school funds.

“This is going to have a tremendous financial impact,” said Robert F. Kitchen, a member of the West Allis-West Milwaukee school board. Officials say some districts may have to cut courses like art and drama, curtail gym and classroom maintenance, or forgo replacing teachers who retire.

Problems were emerging elsewhere, as well.

Depfa’s executives were realizing that their loans to the Wisconsin schools were unlikely to be repaid. Additionally, bonds all over the world were declining in value, exposing the company to the possibility they would have to make good on their pledges as a buyer of last resort. And Depfa was still borrowing billions each month to cover its short-term loans. By autumn, the short-term debt of the bank and its parent company, Hypo, totaled $81 billion.

Then, in mid-September, the American investment bank Lehman Brothers went bankrupt. Short-term lending markets froze up. Ratings agencies, including Standard & Poor’s, downgraded Depfa, citing the company’s difficulties borrowing at affordable rates.

That set off a crisis in Germany, where officials worried that Depfa’s sudden need for cash would drag down its parent company and set off a chain reaction at other banks. The German government and private banks extended $64 billion in credit to Hypo to stop it from imploding.

“We will not allow the distress of one financial institution to endanger the entire system,” Angela Merkel, the German chancellor, said at the time.

That crisis spread almost immediately to the M.T.A.

The transportation authority, guided by Gary Dellaverson, a rumpled, cigarillo-smoking chief financial officer, had $3.75 billion of variable-rate debt outstanding.

About $200 million of that debt was backed by Depfa. When the bank was downgraded, investors dumped those transportation bonds, because of worries they would get stuck with them if Depfa’s problems worsened. Depfa was forced to buy $150 million of them, and bonds worth billions of dollars issued by other municipalities.

Then came the twist: Depfa’s contracts said that if it bought back bonds, the municipalities had to pay a higher-than-average interest rate. The New York transportation authority’s repayment obligation could eventually balloon by about $12 million a year on the Depfa loans alone.

On its own, that cost could be absorbed by the agency. But, as the economy declined, the M.T.A. had lost hundreds of millions because tax receipts — which finance part of its budget — were falling. And its ability to renew its variable-rate bonds at low interest rates was hurt by the trouble at Depfa and other banks. The transportation authority now faces a $900 million shortfall, according to officials. It is “fairly breathtaking,” Mr. Dellaverson told the M.T.A.’s finance committee. “This is not a tolerable long-term position for us to be in.”

In a recent interview, Mr. Dellaverson defended New York’s use of variable bonds.

“Variable-rate debt has helped M.T.A. save millions of dollars, and we’ve been conservative in issuing it,” he said. “But there are risks, which we work hard to mitigate. Usually it works. But what’s happening today is a total lack of marketplace rationality.”

In a statement, the transportation authority said that it was exploring options to reduce the cost of the Depfa-backed bonds, that its variable-rate bonds had delivered savings even during the current turmoil and that the agency had remained within its budget on debt payments this year.

However, the transportation authority has already announced it will raise subway and train fares next year because of various fiscal problems, and may be forced to shrink the work force and reduce some bus routes. Some analysts say fares will probably rise again in 2010.

The Depfa fallout doesn’t end there. Rating agencies have downgraded the bonds of more than 75 municipal agencies backed by Depfa, including in California, Connecticut, Illinois and South Dakota. Officials in Florida, Massachusetts and Montana have cut budgets because of C.D.O.’s or similar risky bets.

And Hypo, the German company that bought Depfa, last week asked the German government for financial help for the third time. Depfa has frozen much of its business, according to Wall Street bankers, and though it continues to honor its commitments, some wonder for how long.

The Wisconsin school districts have filed suit against the Royal Bank of Canada and Stifel Nicolaus alleging misrepresentations. Board members hope they will prevail and schools and retirement plans will emerge unscathed. The companies dispute the lawsuit’s claims. Mr. Noack is not named as a defendant and is cooperating with the school boards.

In Mrs. Velvikis’s classroom at Grewenow Elementary in Kenosha, students have recently completed a lesson in which each first grader contributed a vegetable to a common vat of “stone soup.” The project — based on a children’s book — teaches the benefits of working together. The schools have learned that when everyone works together, they can also all starve.

“Our funding is already so limited,” Mrs. Velvikis said. “We rely on parent donations for some supplies. You hear about all these millions of dollars that have been lost, and you think, that’s got to come out of somewhere.”

NPR will present reports on this topic throughout the week on “Morning Edition,” “All Things Considered” and “Weekend Edition Sunday” and on the Planet Money blog and podcast at


Planet Money

Wis. School Investment Has Worldwide Implications

Audio for this story will be available at approx. 12:00 p.m. ET


“Unfortunately what we thought we bought and what we bought . . . weren't necessarily reality or the truth.”
Marc Hujik, a school board member in Kenosha, Wis.

Weekend Edition Sunday, November 2, 2008 · A story in The New York Times Sunday, co-reported by NPR's global economics unit, Planet Money, examines how the financial crisis links some school districts in Wisconsin with banks in Europe.

In 2006, the school districts thought they were buying some of the safest bonds in the world, but in fact what they purchased were "toxic assets," or collateralized debt obligations, Charles Duhigg, the Times reporter who wrote the article, tells NPR's Liane Hansen.

Collateralized debt obligations, or CDOs, a centerpiece of the current financial crisis, are complex portfolios of diverse fixed-income assets in which buyers can invest their money.

"Unfortunately what we thought we bought and what we bought . . . weren't necessarily reality or the truth," says Marc Hujik, a school board member in Kenosha, Wis.

The school board borrowed $165 million from Depfa, a small Irish bank, to buy the bonds. Depfa, which was actually a German bank that moved to Ireland to save money on taxes, made so many bad deals to U.S. institutions, Duhigg says, that when the big U.S. banks were collapsing, Depfa also started to fail.

That set off a crisis at Depfa's parent company in Germany, Hypo Real Estate Group, and German officials worried about a complete meltdown of the German economy, Duhigg says. So the German government had to pump $75 billion into these banks, which all but put Depfa out of its core business — helping cities and counties and school districts all over the world get cheaper loans.

One of the institutions that is closely connected with Depfa's financing is the New York Metropolitan Transit Authority. With Depfa and world money lenders now in trouble, the MTA will now have to pay millions more to borrow money for projects, with costs likely to be passed on to mass transit riders.

Depfa's reach goes far beyond Wisconsin and New York City. Dozens, perhaps hundreds, of municipal projects across the continent — including affordable housing in Colorado and California and a bridge project in Vancouver — are linked to Depfa and now in trouble.

Saturday, November 1, 2008


By Steve Wiegand | Sacramento Bee

Published: Saturday, Nov. 01, 2008 | Page 3A

California's current budget mess is stalling the state's ability to market bonds or borrow money to ease its cash-flow crunch, officials said Friday.

Gov. Arnold Schwarzenegger's administration, meanwhile, postponed formally releasing the latest bad budgetary news until it can pair it next week with a proposal to clean it up.

Administration officials had originally planned to release their estimate on the current size of the budget's gap between revenues and spending Friday afternoon.

Various state officials – including Schwarzenegger – have informally put the number at from $10 billion to $12.5 billion for the fiscal year that ends June 30.

But H.D. Palmer, a spokesman for the governor's Department of Finance, said the release would be postponed until Wednesday, the day after the election.

That way, Palmer said, it would coincide with Schwarzenegger calling the Legislature into special session to deal with the deficit – and the governor's unveiling of his proposal to close the gap.

"We decided we wanted to do it in one unified package," Palmer said, "the size of the problem and the scope of the solution."

Until there is a solution on the table, the treasurer's office is putting the brakes on issuing any of the billions of dollars in general obligation bonds voters have already authorized but haven't been sold.

It may also postpone trying to seek a $2 billion loan through the issuance of short-term notes that had been scheduled for mid-November. The money would help the state keep afloat while awaiting tax revenues that flow in greater amounts in the spring.

The state issued $5 billion in revenue anticipation notes, or RANs, in mid-October. But it had to pay hefty interest rates of 3.75 percent to 4.25 percent – double the rates other states have paid recently – in part because of the state's shaky financial condition, and in part because of the large size of the issuance.

Since then, the estimated deficit has at least tripled from the $3 billion figure Finance Department officials came up with at the time, making the cost of issuing new notes problematic.

Tom Dresslar, a spokesman for state Treasurer Bill Lockyer, said Friday that "whatever the official (deficit) number turns out to be, the Legislature and governor face the same task they've faced all year: Produce an honestly balanced and gimmick-free budget.

"After the governor announces the official figure and unveils his plan to resolve the problem, we will at that time evaluate our options regarding further issuance of debt in this fiscal year."

Bond market experts said Lockyer's wait-and-see decision was a fiscally prudent move.

If the state issued more notes now, said Jeffrey Small, managing director of the Capitol Public Finance Group, it would run the risk of a low credit rating that would increase the notes' cost.

"Second, because there is not a lot of money coming into the municipal marketplace right now, it would be much more difficult to sell a large $2 billion loan than in the past," Small said.

The impact of the state paying higher interest rates on the money it borrows in the bond market goes beyond driving up the cost for state taxpayers, Small said.

"When the state of California comes out with an interest rate on an eight-month deal of 4.25 percent," he said, "within 15 minutes the level on every other municipal bond out there is going to have to increase," meaning cities, school districts and other local government entities will also pay higher rates on the money they borrow.

While the state's budget mess is adversely affecting bond sellers, however, it's unclear what impact it's having on those who authorize the bonds: the voters.

Numbers released Friday by the Field Poll on the four bond proposals on Tuesday's state ballot found voters were taking a mixed approach:

• Proposition 1A, the $9.95 billion high-speed rail proposal, was favored by 47 percent, down from 56 percent in July.

• Proposition 3, the $980 million children's hospital proposal, was favored by 54 percent, up from July's 47 percent.

• Proposition 10, the $5 billion alternative fuels proposal, was favored by 49 percent.

• Proposition 12, the $900 million veterans housing proposal, was favored by 58 percent.

Neither 10 nor 12 were surveyed by the poll in July.

Field Poll director Mark DiCamillo said he had hypothesized before the survey that many voters would oppose all the bonds because of the state's financial problems.

But the poll found that only about 14 percent of those surveyed were voting no on all the bonds, compared to about 17 percent who were voting for all four.

"The big chunk of voters are saying, 'I'm going to vote yes on some and no on some others,' " he said. "The question is, which ones will they choose?"

DiCamillo said that while all four proposals were leading, the two least costly measures, 3 and 12, were already favored by a majority of voters, while the two pricier proposals had yet to break the 50 percent mark.

"I believe it's the price tags," he said. "The question becomes, 'Will voters also endorse one or both of the bigger-sized bonds?' My gut says they probably won't."