The smart money says the U.S. economy will splinter, with some states thriving, some states not, and all eyes are on California as the nightmare scenario. After a hair-raising visit with former governor Arnold Schwarzenegger, who explains why the Golden State has cratered, Michael Lewis goes where the buck literally stops"”the local level, where the likes of San Jose mayor Chuck Reed and Vallejo ?re chief Paige Meyer are trying to avert even worse catastrophes and rethink what it means to be a society.
On August 5, 2011, moments after the U.S. government watched a rating agency lower its credit rating for the first time in American history, the market for U.S. Treasury bonds soared. Four days later, the interest rates paid by the U.S. government on its new 10-year bonds were plummeting on their way to record lows. The price of gold rose right alongside the price of U.S. Treasury bonds, but the prices of virtually all stocks and other bonds in rich Western countries went into a free fall. The net effect of a major U.S. rating agency's saying that the U.S. government was less likely than before to repay its debts was to lower the cost of borrowing for the U.S. government and to raise it for everyone else. This told you a lot of what you needed to know about the ability of the U.S. government to live beyond its means: it had, for the moment, a blank check. The shakier the United States government appeared, up to some faraway point, the more cheaply it would be able to borrow. It wasn't exposed yet to the same vicious cycle that threatened the financial life of European countries: a moment of doubt leads to higher borrowing costs, which leads to greater doubt and even higher borrowing costs, and so on until you become Greece. The fear that the United States might actually not pay back the money it had borrowed was still unreal.
On December 14, 2010, the television news program 60 Minutes aired a 14-minute piece about U.S. state and local finances. Correspondent Steve Kroft interviewed a private Wall Street analyst named Meredith Whitney, who, back in 2007, had gone from being obscure to famous when she correctly suggested that Citigroup's losses in U.S. subprime bonds were far bigger than anyone imagined, and predicted the bank would be forced to cut its dividend. The 60 Minutes segment noted that U.S. state and local governments faced a collective annual deficit of roughly half a trillion dollars, adding that another trillion-dollar gap existed between what the governments owed retired workers and the money they had on hand to pay them. Whitney pointed out that even these numbers were unreliable, and probably optimistic, as the states did a poor job of providing information about their finances to the public. New Jersey governor Chris Christie concurred with her and added, "At this point, if it's worse, what's the difference?" The bill owed by American states to retired American workers was so large that it couldn't be paid, whatever the amount. At the end of the piece, Kroft asked Whitney what she thought about the ability and willingness of the American states to repay their debts. She didn't see a real risk that the states would default, because the states had the ability to push their problems down to counties and cities. But at these lower levels of government, where American life was lived, she thought there would be serious problems. "You could see 50 to a hundred sizable defaults, [maybe] more," she said. A minute later Kroft returned to her to ask when people should start worrying about a crisis in local finances. "It'll be something to worry about within the next 12 months," she said.
That prophecy turned out to be self-fulfilling: people started worrying about U.S. municipal finance the minute the words were out of her mouth. The next day the municipal-bond market tanked. It kept falling right through the next month. It fell so far, and her prediction received so much attention, that money managers who had put clients into municipal bonds felt compelled to hire more people to analyze states and cities, to prove her wrong. (One of them called it "the Meredith Whitney Municipal Bond Analyst Full Employment Act.") Inside the financial world a new literature was born, devoted to persuading readers that Meredith Whitney didn't know what she was talking about. She was vulnerable to the charge: up until the moment she appeared on 60 Minutes she had, so far as anyone knew, no experience at all of U.S. municipal finance. Many of the articles attacking her accused her of making a very specific forecast"”as many as a hundred defaults within a year!"”that failed to materialize. (Sample Bloomberg News headline: meredith whitney loses credibility as muni defaults fall 60%.) The whirlwind thrown up by the brief market panic sucked in everyone who was anywhere near municipal finance. The nonpartisan, dispassionate, sober-minded Center on Budget and Policy Priorities, in Washington, D.C., even released a statement saying that there was a "mistaken impression that drastic and immediate measures are needed to avoid an imminent fiscal meltdown." This was treated in news accounts as a response to Meredith Whitney, as she was the only one in sight who could be accused of having made such a prediction.
But that's not at all what she had said: her words were being misrepresented so that her message might be more easily attacked. "She was referring to the complacency of the ratings agencies and investment advisers who say there is nothing to worry about," said a person at 60 Minutes who reviewed the transcripts of the interview for me, to make sure I had heard what I thought I had heard. "She says there is something to worry about, and it will be apparent to everyone in the next 12 months."
Whatever else she had done, Meredith Whitney had found the pressure point in American finance: the fear that American cities would not pay back the money they had borrowed. The market for municipal bonds, unlike the market for U.S. government bonds, spooked easily. American cities and states were susceptible to the same cycle of doom that had forced Greece to seek help from the International Monetary Fund. All it took to create doubt and raise borrowing costs for states and cities was for a woman with no standing in the municipal-bond market to utter a few sentences on television. That was the amazing thing: she had offered nothing to back up her statement. She'd written a massive, detailed report on state and local finances, but no one except a handful of her clients had any idea what was in it. "If I was a real nasty hedge-fund guy," one hedge-fund manager put it to me, "I'd sit back and say, "?This is a herd of cattle that can be stampeded.'"?"
What Meredith Whitney was trying to say was more interesting than what she was accused of saying. She didn't actually care all that much about the municipal-bond market, or how many cities were likely to go bankrupt. The municipal-bond market was a dreary backwater. As she put it, "Who cares about the stinking muni-bond market?" The only reason she had stumbled into that market was that she had come to view the U.S. national economy as a collection of regional economies. To understand the regional economies, she had to understand how state and local governments were likely to behave, and to understand this she needed to understand their finances. Thus she had spent two unlikely years researching state and local finance. "I didn't have a plan to do this," she said. "Not one of my clients asked for it. I only looked at this because I needed to understand it myself. How it started was with a question: How can G.D.P. [gross domestic product] estimates be so high when the states that outperformed the U.S. economy during the boom were now underperforming the U.S. economy"”and they were 22 percent of that economy?" It was a good question.
From 2002 to 2008, the states had piled up debts right alongside their citizens': their level of indebtedness, as a group, had almost doubled, and state spending had grown by two-thirds. In that time they had also systematically underfunded their pension plans and other future liabilities by a total of nearly $1.5 trillion. In response, perhaps, the pension money that they had set aside was invested in ever riskier assets. In 1980 only 23 percent of state pension money had been invested in the stock market; by 2008 the number had risen to 60 percent. To top it off, these pension funds were pretty much all assuming they could earn 8 percent on the money they had to invest, at a time when the Federal Reserve was promising to keep interest rates at zero. Toss in underfunded health-care plans, a reduction in federal dollars available to the states, and the depression in tax revenues caused by a soft economy, and you were looking at multi-trillion-dollar holes that could be dealt with in only one of two ways: massive cutbacks in public services or a default"”or both. Whitney thought default unlikely, at least at the state level, because the state could bleed the cities of money to pay off its bonds. The cities were where the pain would be felt most intensely. "The scary thing about state treasurers," she said, "is that they don't know the financial situation in their own municipalities."
"How do you know that?"
"Because I asked them!"
All states may have been created equal, but they were equal no longer. The states that had enjoyed the biggest boom were now facing the biggest busts. "How does the United States emerge from the credit crisis?" Whitney asked herself. "I was convinced"”because the credit crisis had been so different from region to region"”that it would emerge with new regional strengths and weaknesses. Companies are more likely to flourish in the stronger states; the individuals will go to where the jobs are. Ultimately, the people will follow the companies." The country, she thought, might organize itself increasingly into zones of financial security and zones of financial crisis. And the more clearly people understood which zones were which, the more friction there would be between the two. ("Indiana is going to be like, "?N.F.W. I'm bailing out New Jersey.'"?") As more and more people grasped which places had serious financial problems and which did not, the problems would only increase. "Those who have money and can move do so," Whitney wrote in her report to her Wall Street clients, "those without money and who cannot move do not, and ultimately rely more on state and local assistance. It becomes effectively a "?tragedy of the commons.'"?"
The point of Meredith Whitney's investigation, in her mind, was not to predict defaults in the municipal-bond market. It was to compare the states with one another so that they might be ranked. She wanted to get a sense of who in America was likely to play the role of the Greeks, and who the Germans. Of who was strong, and who weak. In the process she had, in effect, unearthed America's scariest financial places.
"So what's the scariest state?" I asked her.
She had to think for only about two seconds.
"California."
At seven o'clock one summer morning I pedaled a $5,000 titanium-frame mountain bike rented in anxiety the previous evening down the Santa Monica beach road to the corner where Arnold Schwarzenegger had asked me to meet him. He turned up right on time, driving a black Cadillac S.U.V. with a handful of crappy old jalopy bikes racked to the back. I wore the closest I could find to actual bicycle gear; he wore a green fleece, shorts, and soft beige slipper-like shoes that suggested both a surprising indifference to his own appearance and a security in his own manhood. His hair was still vaguely in a shape left by a pillow, and his eyelids drooped, though he swore he'd been up for an hour and a half reading newspapers. After reading the newspapers, this is what the former governor of California often does: rides his bike for cardio, then hits the weight room.
He hauls a bike off the back of the car, hops on, and takes off down an already busy Ocean Avenue. He wears no bike helmet, runs red lights, and rips past do not enter signs without seeming to notice them and up one-way streets the wrong way. When he wants to cross three lanes of fast traffic he doesn't so much as glance over his shoulder but just sticks out his hand and follows it, assuming that whatever is behind him will stop. His bike has at least 10 speeds, but he has just 2: zero and pedaling as fast as he can. Inside half a mile he's moving fast enough that wind-induced tears course down his cheeks.
He's got to be one of the world's most recognizable people, but he doesn't appear to worry that anyone will recognize him, and no one does. It may be that people who get out of bed at dawn to jog and Rollerblade and racewalk are too interested in what they are doing to break their trance. Or it may be that he's taking them by surprise. He has no entourage, not even a bodyguard. His former economic adviser, David Crane, and his media adviser, Adam Mendelsohn, who came along for the ride just because it sounded fun, are now somewhere far behind him. Anyone paying attention would think, That guy might look like Arnold, but it can't possibly be Arnold, because Arnold would never be out alone on a bike at seven in the morning, trying to commit suicide. It isn't until he is forced to stop at a red light that he makes meaningful contact with the public. A woman pushing a baby stroller and talking on a cell phone crosses the street right in front of him and does a double take. "Oh . . . my . . . God," she gasps into her phone. "It's Bill Clinton!" She's not 10 feet away, but she keeps talking to the phone, as if the man were unreal. "I'm here with Bill Clinton."
"It's one of those guys who has had a sex scandal," says Arnold, smiling.
"Wait . . . wait," says the woman to her phone. "Maybe it's not Bill Clinton."
Before she can make a positive identification, the light is green, and we're off.
His life has been a series of carefully staged experiences. He himself has no staged presentation of it, however. He is fresh, alive, and improvisational: I'm not sure even he knows what he will do next. He's not exactly humble, but then, if I had lived the life he's lived, I'm not sure I would be, either, though I might try to fake humility more often than he does, which is roughly never. What saves him from self-absorption, aside from a natural curiosity, is a genuine lack of interest in personal reflection. He lives the same way he rides his bike, paying far more attention to what's ahead than what's behind. In office, he kept no journal of any sort. I find it amazing, but he now says he didn't so much as scribble little notes that might later be used to reconstruct his experience and his feelings about it. "Why would I do that?" he says. "It's kind of like you come home and your wife asks you about your day. I've done it once and I don't want to do it again." What he wanted to do after a long day of being governor, more or less, was to lift weights.
We're just a couple of miles in when he zips around a corner and into a narrow alleyway just off Venice Beach. He's humoring me; I've been pestering him about what it was like for him when he first arrived in America, back in 1968, with little money, less English, really nothing but his lats, pecs, traps, and abs, for which there was no obvious market. He stops beside a tall brick wall. It surrounds what might once have been an impressive stone house that now just looks old and bleak and empty. The wall is what interests him, because he built it 43 years ago, right after he had arrived and started to train on Muscle Beach. "Franco [Columbu, like Schwarzenegger a former Mr. Olympia] and I made money this way. In bodybuilding there was no money. Here we were, world champions of this little subculture, and we did this to eat. Franco ran the business. I mixed the cement and knocked things down with the sledgehammer."
Before he stumbled while running downhill with a refrigerator strapped to his back, Columbu was the front-runner in the 1977 contest for the title of the World's Strongest Man, so there was some distinction in being hired by his operation, as Schwarzenegger was, to be the muscle. They had a routine. Franco would play the unreliable Italian, Arnold the sober German. Before they cut any deal they'd scream at each other in German in front of the customer until the customer would finally ask what was going on. Arnold would turn to the customer and explain, Oh, he's Italian, and you know how they are. He wants to charge you more, but I think we can do it cheaply. Schwarzenegger would then name a not so cheap price. "And the customer," he says now, laughing, "he would always say, "?Arnold, you're such a nice guy! So honest!' It was selling, you know."
He surveys his handiwork. "It'll be here for a thousand years," he says, then points out some erosion on the top. "I said to Franco we ought to come back and fix the top. You know, to show it was guaranteed for life."
A poor kid from a small village in Austria, the son of a former Nazi, hops on a plane to America, starts out laying bricks, and winds up running the state and becoming one of America's most prominent political leaders. From post to wire the race takes less than 35 years. I couldn't help but ask the obvious question.
"If someone had told you when you were building this wall that you would wind up governor of California, what would you have said?"
"That would be all right," he said, not exactly catching my drift.
"As a boy," I said, taking another tack, "did you believe you'd lead something other than an ordinary life?"
"Yes." He didn't miss a beat.
"Why?"
"I don't know."
"No one has had this kind of crazy, wild ride," he says as we speed away from the brick wall, but in a tone that suggests the ride was an accident. "I was influenced a lot by America," he said. "The giant six-lane highways, the Empire State Building, the risktaking." He still remembers vividly the America he heard and read about as a boy in Austria: everything about it was big. The only reason he set out to grow himself some big muscles was that he thought it might be a ticket to America.
If there had not been a popular movement to remove sitting governor Gray Davis and the chance to run for governor without having to endure a party primary, he never would have bothered. "The recall happens and people are asking me, "?What are you going to do?'"?" he says, dodging vagrants and joggers along the beach bike path. "I thought about it but decided I wasn't going to do it. I told Maria I wasn't running. I told everyone I wasn't running. I wasn't running." Then, in the middle of the recall madness, Terminator 3: Rise of the Machines opened. As the movie's leading machine, he was expected to appear on The Tonight Show to promote it. En route he experienced a familiar impulse"”the impulse to do something out of the ordinary. "I just thought, This will freak everyone out," he says. "It'll be so funny. I'll announce that I am running. I told Leno I was running. And two months later I was governor." He looks over at me, pedaling as fast as I can to keep up with him, and laughs. "What the fuck is that?"
We're now off the beach and on the surface roads, and the traffic is already heavy. He veers left, across four lanes, arrives on the other side, and says, "All these people are asking me, "?What's your plan? Who's on your staff?' I didn't have a plan. I didn't have a staff. I wasn't running until I went on Jay Leno."
His view of his seven years trying to run the state of California can be summarized as follows. He came to power accidentally, but not without ideas about what he wanted to do. At his core he thought government had become more problem than solution: an institution run less for the benefit of the people than for the benefit of politicians and other public employees. He behaved pretty much as Americans seem to imagine the ideal politician should behave: he made bold decisions without looking at polls; he didn't sell favors; he treated his opponents fairly; he was quick to acknowledge his mistakes and to learn from them; and so on. He was the rare elected official who believed, with some reason, that he had nothing to lose, and behaved accordingly. When presented with the chance to pursue an agenda that violated his own narrow political self-interest for the sake of the public interest, he tended to leap at it. "There were a lot of times when we said, "?You just can't do that,'"?" says his former chief of staff, Susan Kennedy, a lifelong Democrat, whose hiring was one of those things a Republican governor was not supposed to do. "He was always like, "?I don't care.' Ninety percent of the time it was a good thing."
Two years into his tenure, in mid-2005, he'd tried everything he could think of to persuade individual California state legislators to vote against the short-term desires of their constituents for the greater long-term good of all. "To me there were shocking moments," he says. Having sped past a do not enter sign, we are now flying through intersections without pausing. I can't help but notice that, if we weren't breaking the law by going the wrong way down a one-way street, we'd be breaking the law by running stop signs. "When you want to do pension reform for the prison guards," he says, "and all of a sudden the Republicans are all lined up against you. It was really incredible, and it happened over and over: people would say to me, "?Yes, this is the best idea! I would love to vote for it! But if I vote for it some interest group is going to be angry with me, so I won't do it.' I couldn't believe people could actually say that. You have soldiers dying in Iraq and Afghanistan, and they didn't want to risk their political lives by doing the right thing."
He came into office with boundless faith in the American people"”after all, they had elected him"”and figured he could always appeal directly to them. That was his trump card, and he played it. In November 2005 he called a special election that sought votes on four reforms: limiting state spending, putting an end to the gerrymandering of legislative districts, limiting public-employee-union spending on elections, and lengthening the time it took for public-school teachers to get tenure. All four propositions addressed, directly or indirectly, the state's large and growing financial mess. All four were defeated; the votes weren't even close. From then until the end of his time in office he was effectively gelded: the legislators now knew that the people who had elected them to behave exactly the way they were already behaving were not going to undermine them when appealed to directly. The people of California might be irresponsible, but at least they were consistent.
A compelling book called California Crackup describes this problem more generally. It was written by a pair of journalists and nonpartisan think-tank scholars, Joe Mathews and Mark Paul, and they explain, among other things, why Arnold Schwarzenegger's experience as governor was going to be unlike any other experience in his career: he was never going to win. California had organized itself, not accidentally, into highly partisan legislative districts. It elected highly partisan people to office and then required these people to reach a two-thirds majority to enact any new tax or meddle with big spending decisions. On the off chance that they found some common ground, it could be pulled out from under them by voters through the initiative process. Throw in term limits"”no elected official now serves in California government long enough to fully understand it"”and you have a recipe for generating maximum contempt for elected officials. Politicians are elected to get things done and are prevented by the system from doing it, leading the people to grow even more disgusted with them. "The vicious cycle of contempt," as Mark Paul calls it. California state government was designed mainly to maximize the likelihood that voters will continue to despise the people they elect.
But when you look below the surface, he adds, the system is actually very good at giving Californians what they want. "What all the polls show," says Paul, "is that people want services and not to pay for them. And that's exactly what they have now got." As much as they claimed to despise their government, the citizens of California shared its defining trait: a need for debt. The average Californian, in 2011, had debts of $78,000 against an income of $43,000. The behavior was unsustainable, but, in its way, for the people, it works brilliantly. For their leaders, even in the short term, it works less well. They ride into office on great false hopes and quickly discover they can do nothing to justify those hopes.
In Paul's view, Arnold Schwarzenegger had been the best test to date of the notion that the problem with California politics was personal, that all the system needed to fix itself was an independent-minded leader willing to rise above petty politics and exert the will of the people. "The recall was, in and of itself, an effort by the people to say that a new governor"”a different continued from page 183 person"”could solve the problem," says Paul. "He tried every different way of dealing with the crisis in services. He tried to act like a Republican. He tried to act like a Democrat. He tried making nice with the legislature. When that didn't work he called them girlie men. When that didn't work he went directly to the people. And the people voted against his proposals."
The experiment wasn't a complete failure. As governor, Schwarzenegger was able to accomplish a few important things"”reforming worker compensation, enabling open primaries, and, at the very end, ensuring that legislative districts would be drawn by an impartial committee rather than by the legislature. But on most issues, and on virtually everything having to do with how the state raised and spent money, he lost. In his first term Schwarzenegger had set out to cut spending and found he could cut only the things that the state actually needed. Near the end of his second term, he managed to pass a slight tax increase, after he talked four Republicans into creating the super-majority necessary for doing so. Every one of them lost his seat in the next election. He'd taken office in 2003 with approval ratings pushing 70 percent and what appeared to be a mandate to fix California's money problems; he left in 2011 with approval ratings below 25 percent, having fixed very little. "I was operating under the commonsense kind of thing," he says now. "It was the voters who recalled Gray Davis. It was the voters who elected me. So it will be the voters who hand me the tools to do the job. But the other side was successful enough for the voters to take the tools away."
David Crane, the former economic adviser"”at that moment rapidly receding into the distance"”could itemize the result: a long list of depressing government financial statistics. The pensions of state employees ate up twice as much of the budget when Schwarzenegger left office as they had when he arrived, for instance. The officially recognized gap between what the state would owe its workers and what it had on hand to pay them was roughly $105 billion, but that, thanks to accounting gimmicks, was probably only about half the real number. "This year the state will directly spend $32 billion on employee pay and benefits, up 65 percent over the past 10 years," says Crane later. "Compare that to state spending on higher education [down 5 percent], health and human services [up just 5 percent], and parks and recreation [flat], all crowded out in large part by fast-rising employment costs." Crane is a lifelong Democrat with no particular hostility to government. But the more he looked into the details, the more shocking he found them to be. In 2010, for instance, the state spent $6 billion on fewer than 30,000 guards and other prison-system employees. A prison guard who started his career at the age of 45 could retire after five years with a pension that very nearly equaled his former salary. The head parole psychiatrist for the California prison system was the state's highest-paid public employee; in 2010 he'd made $838,706. The same fiscal year that the state spent $6 billion on prisons, it had invested just $4.7 billion in its higher education"”that is, 33 campuses with 670,000 students. Over the past 30 years the state's share of the budget for the University of California has fallen from 30 percent to 11 percent, and it is about to fall a lot more. In 1980 a Cal student paid $776 a year in tuition; in 2011 he pays $13,218. Everywhere you turn, the long-term future of the state is being sacrificed.
This same set of facts, and the narrative it suggested, would throw an ordinary man into depression. He might conclude that he lived in a society that was ungovernable. After seven years of trying and mostly failing to run California, Schwarzenegger is persuasively not depressed. "You have to realize the thing was so much fun!" he says. "We had a great time! There were times of frustration. There were times of disappointment. But if you want to live rather than just exist, you want the drama." As we roll to a stop very near the place on the beach where he began his American bodybuilding career, he says, "You have to step back and say, "?I was elected under odd circumstances. And I'm going out in odd circumstances.' You can't have it both ways. You can't be a spoiled brat."
The odd circumstances were the never-ending financial crises. He'd come to power in the bust after the Internet bubble; he'd left in the bust after the housing bubble. Before and after our bike ride, I sat down with him to get his view of this second event. It was in the middle of 2007, he said, when he first noticed something was not quite right in the California economy. He'd been finishing up budget negotiations and arrived at a number, however phony, where the budget could be declared balanced. An aide walked into his office to give him a heads-up: the tax receipts for that month were less than expected. "We were all of a sudden short $300 million in revenue for the month," says Schwarzenegger. "I somehow felt, Uh-oh. Because there was something in the air." Soon after that he visited the George W. Bush White House, where he gave a talk that was, as ever, upbeat. "At the end of it this guy"”he was the guy who was in charge of housing, I forgot the name. Great guy. For some reason or other he was very honest with me. I don't know why. He probably didn't think I'd go out and blab, which I didn't. He says, "?That was a great speech you gave, but we're heading to a major problem.' I said, "?What do you mean?' He said, "?I looked at some of the numbers, and it's going to be ugly.' That's all he said. He wouldn't elaborate." A housing-price decline in the United States meant a housing-price collapse in California, and a housing-price collapse in California meant an economic collapse and a decline in tax revenues. "The next month our revenues came in short $600 million. By December we were short a billion."
At some point in our talks I asked Schwarzenegger how much time he had spent, as governor, grappling with the on-the-ground local implications of the big state crisis. The question pretty clearly bored him. "I'm not into the local stuff," he'd said. "I was born for the world."
About an hour into the weekly meeting of the San Jose City Council, I find myself wishing that I, too, was born for the world. A hundred citizens yawn and text as the council honors National Farmers Market Week; the few people who seem to be paying attention get up and leave after the honor is bestowed. The council commemorates August 7 as Assyrian Martyrs Day, "honoring the massacre of three thousand people in August 1933, and recognizing 2,000 years of persecution of Assyrian Christians." Maybe 30 people turn their attention from their cell phones to the ceremony, but then they, too, rise and exit the chamber. A mere handful of people are left to hear the San Jose city manager offer the latest bleak financial news: the state of California was clawing back tens of millions of dollars more, and "140 employees have been separated from the city." (New times call for new euphemisms.) A pollster presents his finding that, no matter how the question is phrased, the citizens of San Jose are unlikely to approve any ballot measure that raises taxes. A numbers guy gets to his feet and explains that the investment returns in the city's pension plan are not likely to be anything near as high as was assumed. In addition to there not being enough money in this particular pot to begin with, the pot is failing to expand as fast as everyone had hoped, and so the gap between what the city's employees are entitled to and what will exist is even greater than previously imagined. The council then votes to postpone, for six weeks, a vote on whether to declare the city's budget a "public emergency," and thus to give to the mayor, Chuck Reed, new powers.
Following each motion an obese man not so much dressed as enshrouded in blue-jean overalls maximizes his right to be heard for five minutes on every subject: over and again he rises from the front row of the audience, waddles to the podium, and delivers sophisticated-sounding but incomprehensible critiques of everything. "The absolute reduction in competence of government is predicated on what happened today . . . "
The relationship between the people and their money in California is such that you can pluck almost any city at random and enter a crisis. San Jose has the highest per capita income of any city in the United States, after New York. It has the highest credit rating of any city in California with a population over 250,000. It is one of the few cities in America with a triple-A rating from Moody's and Standard & Poor's, but only because its bondholders have the power to compel the city to levy a tax on property owners to pay off the bonds. The city itself is not all that far from being bankrupt.
It's late afternoon when I meet Mayor Chuck Reed in his office at the top of the city-hall tower. The crowd below has just begun to chant. The public employees, as usual, are protesting him. Reed is so used to it that he hardly notices. He's a former air-force officer and Vietnam-era veteran with an intellectual bent and the clipped manner of a midwestern farmer. He has a master's degree from Princeton, a law degree from Stanford, and a lifelong interest in public policy. Still, he presents less as the mayor of a big city in California than as a hard-bitten, upstanding sheriff of a small town who doesn't want any trouble. Elected to the city council in 2000, he became mayor six years later; in 2010 he was re-elected with 77 percent of the vote. He's a Democrat, but at this point it doesn't much matter which party he belongs to, or what his ideological leanings are, or for that matter how popular he is with the people of San Jose. He's got a problem so big that it overwhelms ordinary politics: the city owes so much more money to its employees than it can afford to pay that it could cut its debts in half and still wind up broke. "I did a calculation of cost per public employee," he says as we settle in. "We're not as bad as Greece, I don't think."
The problem, he explains, pre-dates the most recent financial crisis. "Hell, I was here. I know how it started. It started in the 1990s with the Internet boom. We live near rich people, so we thought we were rich." San Jose's budget, like the budget of any city, turns on the pay of public-safety workers: the police and firefighters now eat 75 percent of all discretionary spending. The Internet boom created both great expectations for public employees and tax revenues to meet them. In its negotiations with unions the city was required to submit to binding arbitration, which works for police officers and firefighters just as it does for Major League Baseball players. Each side of any pay dispute makes its best offer, and a putatively neutral judge picks one of them. There is no meeting in the middle: the judge simply rules for one side or the other. Each side thus has an incentive to be reasonable, for the less reasonable they are, the less likely it is that the judge will favor their proposal. The problem with binding arbitration for police officers and firefighters, says Reed, is that the judges are not neutral. "They tend to be labor lawyers who favor the unions," he says, "and so the city does anything it can to avoid the process." And what politician wants to spat publicly with police officers and firefighters?
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