The Roadblock to Obama's Infrastructure Dreams

President-elect Obama's call for enormous new investment in national instructure has the potential, as Steve Coll recently noted, to both stimulate the economy in the short run and strengthen it for the long haul. But as the situation in California illustrates, the economy cannot get the full benefit of that infrastructure package unless the stimulus package also includes a large dose of direct aid to state budgets.

In every respect but one, California is ideally positioned to take advantage of Obama's infrastructure plans. With its congested freeways, crumbling levees, and burgeoning population, it has boundless infrastructure needs. It has existing voter authorization to issue tens of billions worth of state bonds to cover the state's share of cost for projects. It has a bountiful supply of workers, now idled by the collapse of housing construction, to retrofit buildings for energy efficiency or to repair schools and public buildings. It has a vigorous corps of entrepreneurs and venture capitalists to spur a wave of green infrastructure investments, contributing new ideas and technologies to the effort.

It has everything to carry out an infrastructure stimulus program except cash.

Speaking December 8 to an unusual joint session of the California Legislature, Treasurer Bill Lockyer announced that, as of December 17, the state of California, its till increasingly bare, will have to stop providing the short-term cash financing needed by most state infrastructure projects. Billions of dollars worth of planned and approved projects –– school builidings, road and transit projects, levee improvements –– will come to a stop, resulting in the loss of $12.5 billion worth of private sector activity and 200,000 jobs, according to Lockyer's estimate.

When the media and politicians talk about infrastructure and bonds, the discussion usually involves a simple shorthand: Voters approve bonds; state sells bonds; state uses bond proceeds to build projects. In actual fact, the financial plumbing is more tangled. Because of federal tax laws, most infrastructure financing must follow a two-step process. When a state agency is ready to begin an infrastructure project with authorized bond funding, it first applies for a loan from the state's Pooled Money Investment Account, the cash reserve where state and local revenues and special fund cash balances are temporarily parked until they are needed. This bridge financing is used to build the project. Once the project is ready, the state sells authorized bonds and uses the proceeds to pay the short-term loan with interest.

In normal times, this process works seamlessly and without any public attention. (In the 18 months I served as executive secretary of the Pooled Money Investment Board, I never saw a reporter at a board meeting.) But today it is ready to break down.

The state's cash reserves, already depleted by years of internal borrowing and budget gimmickry, are fast draining as the recession drives down revenue collections. To make matters worse, the meltdown of the financial markets prevented the state earlier this autumn from being able to sell the full amount of revenue anticipation notes it normally issues to keep its cash drawer full until most of its tax revenues arrive in the spring. Because the pool in the state's cash reserve is already so low, all of the remaining dollars will have to be loaned to the general fund over the next several months to pay day-to-day bills, leaving none available for infrastructure financing. And without drastic and immediate action by the Legislature to raise taxes or cut state programs, the state will run out of cash, in February or March, for any purpose. In Governor Schwarzenegger's words, California is "headed toward a financial Armageddon."

Yet even drastic action won't be enough to make infrastructure financing available in California for more than a few months. At the same joint session, Controller John Chiang told lawmakers that the state's revenue loss is so great that the cash crisis will return next summer, at the beginning of the next fiscal year, in which the state faces a projected deficit of $19 billion, roughly equal to 20 percent of its general fund. To close that deficit by spending cuts alone would require closing the University of California and the California State University system, ending welfare payments, and eliminating all state funding for the developmentally disabled, for mental health, and for In-Home Supportive Services.

Given that the California Legislature has been unable, to date, to take budget actions, either tax increases or spending cuts, far less painful than these, it seems unlikely that California finances will permit the normal funding of infrastructure at any time in the next several years.

Obama has said he will provide infrastructure funding for the states, which must use it quickly or lose it. But without federal assistance to cope with its budget calamity, California, and likely other states as well, will be in no financial shape to take full advantage of this infrastructure moment. As I have written before, using the coming stimulus bill to bolster state finances is essential to prevent state budget actions from deepening the recession. But as California's plight illustrates, generous assistance to the states, on the order of $100 billion to $150 billion, is also vital to making Obama's infrastructure hopes come alive.