In fact, one of Schwarzenegger’s memorable campaign lines–“the public doesn’t care about figures”–is arguably a true lie. It’s true on one level: he got elected without producing any numbers of substance. But it’s not true on another. Voters cared passionately about at least one number: $38 billion, California’s stated budget deficit earlier this year. Concern over this huge figure helped send Gray Davis packing. It let Schwarzenegger ride in by promising to open the books, not raise taxes and make everything work by eliminating waste, fraud and abuse.
The high-stakes suspense is more than just entertainment for the rest of the country. If the state’s finances melt down–unlikely, but certainly possible–it would terrify the world’s financial markets. If California were a separate country, it would be the sixth largest economy in the world, which probably makes it too big to fail. But who wants to find out? The clock is ticking, and Schwarzenegger has to act fast.
On the surface, Schwarzenegger faces an impossible task. California has plunged deep into deficit since 2000, when the stock bubble burst, tech melted down and the state’s income-tax revenues from capital gains and stock-option profits fell from $18 billion a year to $5 billion. About 40 percent of general-fund revenues must go to education, thanks to Proposition 98, and an additional 25 percent goes to matching health and welfare mandates from the federal government. You’d have to eliminate at least a third of everything else–including universities and prisons and other necessities–to bring the budget into true balance overnight. Not likely.
But in California budgets, as in movies, things often aren’t what they seem. For instance, the widely reported $38 billion deficit that got Davis into so much trouble was actually for two years, not one. Big difference. The state’s balanced-budget requirement, which many people consider a steep hurdle, can be gamed. “They roll over prior years’ accumulated deficits into future years,” says David Hitchcock, Standard & Poor’s chief California-debt analyst. The state “balanced” its current budget by counting as revenue $15 billion from bond issues, most of which haven’t been sold yet.
Even if he never finds the billions he promises to cut, Schwarzenegger can muddle through if he gets a few breaks. If lenders keep the money flowing, there’s no immediate need for the state’s revenues to match its expenditures. With luck, he can fix the state’s overly costly Worker Compensation program and renegotiate expensive electricity contracts that the state signed during its 2001 “energy crisis.” President George W. Bush may send a few extra billion California’s way as a reward for the regime change. The state’s economy may revive, boosting personal income-tax revenue. That kind of thing has bailed out California in the past–albeit with much smaller numbers–and could work again.
Schwarzenegger would have a much easier time if he were trying to turn around a company rather than a state. The problem with his new job is that he can’t order people around; he has to win them over. And some important Democrats, including State Senate Majority Leader John Burton, aren’t exactly onboard. Burton told NEWSWEEK that he was offended by Schwarzenegger’s repeated vows to open the budget for the people. “It sounds good, but the f—ing budget is an open book,” Burton said. “It’s a public document.” Burton doubts that Schwarzenegger’s highly touted auditors will find the billions of dollars of waste he’s talked about. “It’s not going to be a walk in the park,” Burton said.
The budget is tricky and complicated–but the major elements, as Burton says, are readily accessible. State Treasurer Phil Angelides’s August bond-sales pitch to Wall Street is on a state Web site, full of details about the projected deficits and how the state claims to be closing them. And there’s no shortage of analyses from credit-rating firms like S&P and Moody’s, which have downgraded California’s debt ratings.
Now for the nightmare scenario. The state is counting on selling $12.6 billion of bonds to repay short-term borrowings that it used to pay bills and balance the budget. It’s as if you maxed out the cash advances on your credit cards, intending to repay them when you refinanced your mortgage. But the bonds are being challenged in separate suits by groups that argue they would violate state law. If the state can’t sell the bonds, it will have to refinance the short-term debt when it comes due in June. And it will have to find some $10 billion or so to cover the ongoing deficit in the current budget. It may not be able to raise that kind of money. While a meltdown is possible, it seems less likely under Governor Schwarzenegger than under Governor Davis. “When new management comes into a troubled company, you almost always see the securities markets react favorably to the change,” says San Francisco financier Warren Hellman, who opposed the recall as bad for business before switching to Schwarzenegger. Warren Buffett, a Democrat whose early support lent Schwarzenegger immense credibility, seems to have had similar thoughts. Buffett, a board member of NEWSWEEK’s parent, The Washington Post Company, wouldn’t come to the phone. But people who’ve talked to Buffett say he feared that, absent dramatic change in Sacramento, the state’s finances would melt down.
Will Schwarzenegger prevail, the way he does in most of his movies? Or will his venture into politics and budget-balancing evoke the final scenes of “Terminator 3,” where the world is laid waste in a nuclear holocaust? This is one script that he’ll have a hard time controlling.
