Schwarzenegger Builds His Body Politic
By Andy Serwer

(FORTUNE Magazine) – I remember sitting at the anchor desk of CNN's American Morning last fall when Arnold came on for an interview, and saying to myself, "This guy is really good at answering questions--I bet he's going to win." But I also remember wondering if Arnold would end up being California's version of Jesse Ventura: quick with a one-liner but weak on the follow-through, and ultimately ineffectual. Well, it's very early yet, but so far the Governator's game plan seems to be on track.

We all know that in business as well as in politics, instilling confidence--i.e., making constituents believe that things are improving--is a major part of the battle. I recently spoke about that with Arnold's unofficial financial brain trust (yes, Warren Buffett), who, though predictably positive, had an interesting perspective. "I just saw Arnold," Buffett told me. "We were making a little movie for the Berkshire annual meeting, which I'm sure is going to be Oscar material. Before that I was with him in New York, where we met with some Wall Street people and I compared Arnold's first 100 days to Roosevelt's, 71 years earlier. I think the psychological turnaround in California is very dramatic. He's getting people to work together out there. And he's a great salesman."

Yes, but what has Arnold really done? Well, most significant, in March he won approval for two referendums, Proposition 57, which allowed the state to sell $15 billion in new bonds--essentially emergency funding--and Proposition 58, which stipulates that the state's budget must be balanced going forward. And he did it by garnering bipartisan support. But there's still plenty of work ahead. As David Hitchcock, a bond analyst for S&P, says, "Liquidity concerns have gone away, but the fundamental problem that got them there hasn't changed." California still has the lowest debt rating of any state in the nation. And despite the passage of Prop 57 and Prop 58 and Arnold's Wall Street visit with Buffett, the credit-rating agencies raised only their outlook for the state, not its actual credit rating. Perhaps that will come. Spreads on California's bonds have been narrowing lately, as investors perceive the situation is improving and demand less of a premium.

From here, though, the going gets even tougher. On Sunday night, March 28, Arnold met with legislators trying to hammer out new cost-cutting rules for California's sky-high workers' comp insurance, which has risen from $2.68 per $100 of payroll in 2000 to $6.33 per $100 in 2003. The costs are blamed for companies' leaving the state, and Schwarzenegger has vowed to put a lid on them. In June he faces an even bigger challenge--a new budget, which right now has a projected $14 billion shortfall, according to the state's department of finance. Arnold's answer: Cut spending by some $11 billion and plug the rest with Prop 57 bonds.

One measure Arnold has so far avoided is raising taxes or levying new ones. I asked Buffett whether Arnold would ultimately have to bite the bullet. "I'm not going to comment on that one," Buffett responded with his trademark chuckle. (You may remember that Buffett created a firestorm during the recall process when he took a jab at California's sacred cow, Proposition 13, which limits real estate taxes.) Hey, Arnold! Here's a free piece of advice. You're a tough guy, so bite the bullet. Raising taxes a notch for the wealthiest 1% of Californians will go a long way toward solving the state's fiscal woes. And trust me, it won't get you recalled either. Do it--and do it now, while you still have the political capital. As Buffett said to me about you, "The train was moving in the wrong direction. He turned it around. Now he has to keep the train moving."

ANDY SERWER, editor at large of FORTUNE, can be reached at Read him online in Street Life on and watch him on CNN's American Morning and In the Money.