State bailouts

I agree with most of what Stan and Pete have already posted.  Paul Krugman nicely pointed out the obvious: " ... California has immense human and financial resources. It should not be in fiscal crisis ..."  California's current predicament has been caused by its self-imposed political dysfunction.

There are plenty of resources in California to tax to pay for the state's budget.  If the California legislature is unable to raise the needed revenue or cut the excess spending beyond the revenue it can raise, then the governor may have to go hat in hand to Washington.  What should he find when he gets there?  A firm response that a precondition for any special assistance in the short term is a set of fiscal changes that ensure that there will be more than enough money in the state's general fund to pay back the money, at a high rate of interest, over the long term. 

Pete has nicely summarized the history of the ongoing budget situation in California and state and local government bailouts in general.

But Pete missed the most important point as he retold the important story about Alexander Hamilton: the move was also intended to show the bond market of its time that the new United States government was worthy of its confidence...and its money.  Hamilton was convinced that no one would lend to the new U.S. if it didn't assume the debts of the colonies and instead repudiated them as being someone else's responsibility.

That's the real lesson here: The state of California may be a government with an economy larger than most countries, but since 1850 it has been part of the U.S.  A default in California will have disastrous effects not just there and in the other 49 states, but also for every county and municipal government that borrows and, inevitably, for the United States itself.  Some governments will be unable to borrow at all.  Those that are able to borrow will be required to pay much higher interest rates for the privilege.