When the words bankruptcy and default come up in the context of California's financial crisis, they have the tendency to unnecessarily scare the heck out of many people. As we pointed out in Part 1 last Monday, the situation IS dire, in fact, VERY dire, but let's discuss what all this rhetoric really means.
First of all, a default differs materially from a bankruptcy. A default is the failure to make required debt payments on a timely basis or to comply with other conditions of an obligation or agreement. Bankruptcy, on the other hand, is defined as the condition of a legal entity that does not have the financial ability to pay their incurred debts as they come due. In the case of California, the use of "IOUs" has precluded, for the time being, a default.
Therefore, a series of defaults must occur BEFORE a bankruptcy. So, an entity can be in default WITHOUT being bankrupt, but it cannot be bankrupt without first being in default.
There is precedent for individual states to be in default. According to an article by William B. English titled "Understanding The Costs of Sovereign Default: American State Debts In the 1840's", 9 states went into default between 1841 and 1843. One of which was Florida, which was, at that time, considered to be a territory,
Of these defaulting states, 5 had already repudiated their debt in all or part by the end of the decade. The other 4 used a variety of factors to ultimately fix THEIR problems.
According to Mr. English, these debts are seen as "sovereign" debts, or debts of the COUNTRY. The Constitution currently precludes enforcement of these debt through lawsuits. Therefore, a State bankruptcy, for the time being, is IMPOSSIBLE.
California, despite its recent hardships, still has the 9th largest economy IN THE WORLD, if viewed on a stand-alone basis. Therefore, it is WAY too critical to the world to let the Golden State default, let alone go bankrupt.
The only conclusion one could reasonably draw, is that the frequent use of the words default and bankruptcy in the context of California is nothing more than an irresponsible scare tactic. Its likely intent is to bully the Federal Government into providing bailout funds sooner rather than later. Although, to be fair, California MAY be bordering on default status, since it IS issuing IOUs as discussed at length in Part 1 last week.
None of this is intended to suggest that a State default cannot happen, especially if California's worsening financial condition continues to deteriorate. State defaults have precedent, while State bankruptcies DO NOT.
Finally, I do appreciate feedback and comments, pro or con. I will continue to provide regular updates on California as they become material. In the meantime, I will cover Gold, Silver and other timely and relevant topics.