Bankruptcy

The key problem in California is that the state budget is comprised of many fixed expenses. Many of these were put in place by voter initiatives. That leaves a relatively small part of the budget (welfare programs and the Universities are two of the larger ones) that can be adjusted down when tax revenues fall, such as they have been, because people's incomes have fallen.

So California faces a tough choice of radically cutting its budget -- which may have collateral economic consequences, for example, cutting welfare will dramatically cut spending by the poor -- or finding some other source of "plugging" the hole in its budget. One possible solution would be to borrow money from the federal government. The federal government might consider doing this if it believes that the austerity measures required to balance California's budget would have knock-on effects for the national economy. Given that California's economy is the biggest single part of the national economy -- California's GDP is comparable to France or Canada -- this would not be an unreasonable assumption.

On the other hand, the politics are quite complex. The Republicans in California hold a blocking position (by virtue of rules that require a 2/3 majority in the legislature to pass a tax increase), and generally hope to use the present situation to achieve the kind of minimalist state government they have always desired. And the Obama Administration has to fear that Republicans in Washington, including some from California, will criticize any further government involvement in the economy, particularly involvement that increases the federal debt load.