Will California Default?

California municipal bonds have just plummeted these past few days as investors worry about the ability of California to repay its bond obligations. California faces a massive $25 billion shortfall in revenues to fund state obligations, and Governor Schwarzenegger has been wracking his head over how to do it.

Chris Whalen, a financial industry analyst and Managing Director of Institutional Risk Analytics, thinks that California will eventually one day default on its debt, which will simply kill all the pension funds and other investors who have loaded up on what they thought were safe state bonds. He feels CA will not immeidately default but will first issue IOUs like last year, but debts will eventually have to be restructured and bond owners will get less than 100 cents on the dollar. You can watch an Interview on Yahoo Finance’s Tech Ticker here.

If Whalen is right, the U.S. could have another major crisis on its hands. If California is bailed out by the federal government, then New York, Illinois and other states are not far beyond. The problem is simply that states have made obligations, such as defined benefit pension plans, that they cannot fund. And now the piper has come to collect.