This is a RUSH transcript from "The O'Reilly Factor," February 1, 2010. This copy may not be in its final form and may be updated.

Watch "The O'Reilly Factor" weeknights at 8 p.m. and 11 p.m. ET!

BILL O'REILLY, HOST: In the "Personal Story" segment tonight: We'd like to welcome the mayor of San Francisco, Gavin Newsom. This is the mayor's first appearance in the No Spin Zone, and many people in the City by the Bay are asking why the heck is he doing it? So, Mr. Mayor, why the heck are you doing it?

GAVIN NEWSOM, MAYOR OF SAN FRANCISCO: Actually, I watch you every night. I hate to admit this.


NEWSOM: This is going to hurt my progressive base. But I think either you're becoming more moderate, or I'm becoming more moderate. One of the two.

O'REILLY: Yeah, it's the latter.

NEWSOM: I'm starting to agree with some you're saying.

O'REILLY: It's the latter. There's no doubt about it. Well, look, we try to base, you know, if you watch our program or not, our opinion on facts. And I want to talk to you about liberal governance. First of all, I put forth that the country's moving to the right, and I think the Massachusetts vote showed that. Am I wrong?

Click here to watch the interview!

NEWSOM: I don't know if it's necessarily moving to the right. I think people distrust big government, and I think folks are looking for real reform. President Obama ran on a reform agenda and we're seeing when he got into Washington that it was business as usual, just different players, different constituencies, a different ideology. At the end of the day, I think the Coakley race was really a referendum on the inside baseball nature of politics today. So I'm not disappointed in small government. It's effective government.

O'REILLY: In your opinion, they're disappointed in President Obama's performance and that he didn't break away from the Washington establishment, so they sent him a message through Scott Brown.

NEWSOM: Yeah. I think there's a populist upheaval happening in this nation. I think, and I've said this before, that we reject the tea party populism at our own peril as Democrats. There's extreme elements there, and they're rightly being shown the door. But I think generally, people are frustrated and concerned. A lot of independents out there that are not ideological, Republican or Democrat, that are concerned about our fate and future, and I think it's wise for us to pay some attention to that.

O'REILLY: OK, but nowhere more than California are people frustrated because the state is bankrupt. And over the last — next 18 months, you guys have a $20 billion gap. That means you got to spend $20 billion that you don't have.


O'REILLY: Now, Sacramento is dominated by liberals. And California in the last 30 years has really drifted to the left, as have the city of San Francisco. Somebody looking at this would say liberal governance simply doesn't work. You cannot afford the entitlement programs that liberals want to put out there, and I think California proves that beyond a reasonable doubt.

NEWSOM: I don't think it's that simple, Bill, with respect. Look, I come from a progressive city. We are balancing our budgets without raising taxes, without borrowing. Our bond rating was reaffirmed last year. We have a rainy day reserve. We have pay as you go. We have 10-year capital plans. We also do universal health care, the only city in America. Universal pre-school. No teachers were laid off, firefighters or nurses last year. And we're able to do that with a progressive framework. The state of California is run by a Republican governor. It's not just progressives.

O'REILLY: Yeah, but he doesn't have any say over what the legislation does. But the city of San Francisco owes a ton of money, $6.6 billion, right?

NEWSOM: Yeah, that's our budget. And the state of California should hardly cry poverty as well.

O'REILLY: No, no, but you just said, look, the city of San Francisco is meeting its obligations and has a bunch of progressive programs. But I'm saying, tell me if I'm wrong, you got a $6.6 budget shortfall. You're $ 6.6 billion…

NEWSOM: No, we had a $6.6 billion budget. We have a $522 or so million shortfall. Look, last year, I had a $438 million shortfall. But we didn't raise taxes. We didn't borrow.

O'REILLY: But that's…

NEWSOM: Our bond rating, as I said, was reaffirmed. And we were still able to invest in people…


NEWSOM: ...and programs. So look, I don't just reject the notion that liberals can't govern. In fact, in many ways, San Francisco's an example that we can for all our pratfalls, challenges, for all the things that obviously highlighted and you've highlighted some of them, that you may disagree with, but we actually operate in a rather fiscally conservative manner, as surprising as that may be to a lot of your viewers.

O'REILLY: OK, but the state of California and the city of San Francisco are spending more money they're taking in. The city — the state of California under Governor Schwarzenegger is bankrupt. You're losing population, which is astounding because California's such a beautiful place to live.


O'REILLY: Businesses are fleeing. The state is in dire, dire economic trouble under a very liberal legislature in Sacramento. So I'm trying to be convinced that the progressive vision…


O'REILLY: ...is fiscally sound. I can't be convinced of that. And in the United States of America, we owe $13 trillion. I mean, how long can this go on? Don't you see that the folks are going enough's enough?

NEWSOM: No, again, I don't disagree fundamentally, though I do suggest take a look more closely at San Francisco. You can't find a more progressive city that's managed. And we've been able to manage — read our bond rating.

O'REILLY: You know, look.


O'REILLY: Let me speak to you frankly about San Francisco.

NEWSOM: To understand what we're doing, but…


NEWSOM: …we have a $20 billion shortfall. Yeah.

O'REILLY: San Francisco used to be my favorite city in the country to visit. It is no longer because you got panhandlers everywhere. They're aggressive. They go to the bathroom in the street. You give them money. They buy heroin with the money. You got medical marijuana clinics all over the place. You, yourself, said it's out of control. We got to shut some of them down.


O'REILLY: You got a libertine philosophy that transvestite nuns break into a Catholic Church, and you condemned it. But nobody else did. And embarrassed the priest and did everything like this. I, you know, I'm uncomfortable going to San Francisco now.


O'REILLY: And I wasn't uncomfortable up to a decade ago. Now, it looks like the inmates are controlling the asylum, if you know what I'm talking about.

NEWSOM: Yeah, look, I — if, you know, you're a good litigator. You're just focusing on one small…


NEWSOM: ...piece of the overall picture.

O'REILLY: True. There are beautiful parts of the city, but these are the parts of the city…


O'REILLY: …that tourists like me stand in the hotel on Nob Hill are seeing. We're walking down the street…

NEWSOM: Yeah, but let me…

O'REILLY: ...and we're accosted by seven guys. You know, that's not good for kids.

NEWSOM: Bill, I — and you're right. It's not good for the city and its image. And you're not wrong to make this point. But let me make this counterpoint. 10,585 people off the street since I've been mayor, a 40 percent reduction in the street population. We converted cash to guaranteed access of services, a care on cash initiative, a welfare reform that's reduced our case load by 83 percent. We are making real progress. And with respect to 10 years ago, I can assure you the phenomenon of panhandling is not unique to San Francisco.

O'REILLY: No, but…


O'REILLY: ...if you compare San Francisco to New York, where they don't allow it, you don't see it. It's big, big, big difference. I'll give you the last word.

NEWSOM: Look, we can do a much better job, I acknowledge that. But please, don't just think it's because of progressive politics. State of California Republican governor, they've got real problems. The biggest problem is governance. We need a constitutional convention in the state of California. We need to change the framework of government.

O'REILLY: Right, I might move out there and run for governor.

NEWSOM: There's a lot of reform that's necessary.

O'REILLY: And solve all the problems.

NEWSOM: Well, we may need you, Bill.

O'REILLY: I appreciate you coming on though. It's good to see you. Thank you.

NEWSOM: Pleasure to be here.

Content and Programming Copyright 2010 Fox News Network, Inc. Copyright 2010 Roll Call, Inc. All materials herein are protected by United States copyright law and may not be reproduced, distributed, transmitted, displayed, published or broadcast without the prior written permission of Roll Call. You may not alter or remove any trademark, copyright or other notice from copies of the content.