Washington and Wall Street seem to be treating California as if it were a sideshow in the financial circus of these turbulent times.

It’s not.

California is home to the largest manufacturing belt in the United States and to Silicon Valley, the nation’s largest high-tech center.

California is America’s most populous state with 38 million people. Its GDP of $1.8 trillion is the largest in the U.S. Its economy is bigger than those of Russia, Brazil, Canada, or India.

And it’s collapsing.

Major California counties are ground zero in the continuing mortgage meltdown:

Los Angeles County with 5.32 percent of mortgages 90 days past due … Monterrey County, 8.02 percent … Imperial, 8.13 … San Bernadino, 8.66 … Madeira, 9.21 … San Joaquin, 9.53 … Riverside, 10.2 … Merced, 10.57 … and more!

California’s inventory of foreclosed homes is skyrocketing. Home prices are plunging. And the impact of surging unemployment is just beginning to show up in the data …

(ARTICLE CONTINUES BELOW)

Worst Unemployment in 64 Years

The state’s unemployment rate has surged to 11.5 percent, the worst since World War II.

Last month, California lost 68,900 jobs. And since July 2007, it has lost 859,000 jobs, including 739,500 just in the past 12 months.

Even if the economy recovers, an unlikely scenario in my view, economists agree that California will continue to be slammed by layoffs, at least through the end of this year and probably well into 2010.

And even assuming a national recovery, UCLA’s Anderson Forecast projects an average unemployment rate of 12.1 percent from this fall through next spring.

What about without a national recovery? California’s jobless could go beyond 15 percent.

Worse, if you include part-time workers seeking full-time work plus workers who have given up looking entirely, it could reach 25 percent, exceeding the worst national unemployment levels of the Great Depression.

“Our wallet is empty.
Our bank is closed. And
our credit is dried up.”

These are not the words of a Dr. Doom in New York or a forlorn banker in Georgia. They represent the confession of Governor Arnold Schwarzenegger before a rare joint session of the California legislature … and with no exaggeration!

The state faces a stunning $24.3 billion budget deficit, even assuming no significant deterioration in the economy from this point onward. And the state has lost virtually all hope of President Obama declaring, “California is too big to fail.”

California State Treasurer Bill Lockyer tried to make that argument to Washington, and did so with great vigor. But he was rejected. After the long line-up of failed companies with hat in hand in recent months — on the steps of Congress or the White House lawn — some folks in government finally appear to have learned how to just say “no.”

“You’re on your own,” is the message from the president to the governor. “Beyond your share of the stimulus package, that’s it! No more!”

Result: The inevitability of massive state cutbacks, including large numbers of state jobs getting axed — all while the California jobless rate is already 11.5 percent.

How many state jobs are in jeopardy? Right now, Schwarzenegger is proposing laying off 5,000 state employees, as well as slashing education and social welfare programs. But the Anderson Forecast projects that Schwarzenegger’s budget cuts will eventually result in 64,000 job cuts from state government plus countless private-sector and local government jobs.

Massive Downgrades Coming

California’s credit rating is already the lowest among all U.S. states.

But with Moody’s, S&P, and Fitch still greatly influenced by massive conflicts of interest, it’s not nearly low enough.

And sure enough, on Friday, Moody’s tacitly admitted as much, announcing that it may have to cut California’s rating by several notches in one fell swoop!

Standard & Poor’s put California on watch for a possible downgrade a few days earlier. Fitch did the same May 29.

The big problem: Once downgraded, California’s rating is likely to fall below the minimal level legally required for most money market funds, forcing these funds to dump California paper posthaste.

Moody’s wrote:

But lack of action is precisely what Sacramento is now becoming most famous for. In fact, in their latest scuffle, Democrats proposed a budget that would raise $2 billion from cigarette taxes and oil companies. But the governor promptly vetoed the plan. So now Sacramento is in a new, escalating battle over the deficit just weeks before the state is expected to run out of cash to meet payroll and other bills.

State officials continue to insist that a state default is unthinkable … much like GM executives said their bankruptcy could never happen.

In my view, there is a very HIGH probability that California will default.

It’s obvious its debt merits a junk bond rating from every Wall Street rating agency.

And it’s equally obvious that the ratings agencies are artificially inflating the rating, stalling downgrades, and grossly understating the risk to investors.

My recommendations:

1. If you wait for Moody’s or S&P to act, it could be too late. Even if you can’t get what you might consider a good price, sell all California paper now!

2. Seriously consider dumping all tax-exempt bonds. I know the income is better than equivalent Treasuries. But if California defaults, it could set off a chain reaction of bond price plunges and defaults throughout the municipal bond market.

3. Don’t underestimate the impact California’s depression is having — and will continue to have — on the rest of the U.S. economy. At $1.8 trillion, the state’s GDP is so large, any further deterioration could wipe out every so-called “green shoot” in the national economy seen to date.

4. Stay safe, with a big portion of your nest egg in cash, tucked away in short-term Treasury bills … and with a very modest portion in gold, as an insurance policy against a dollar decline.

Good luck and God bless!

Martin