California debt rating cut as cash crunch looms

SAN FRANCISCO Wed Jan 13, 2010 8:06pm EST

California Governor Arnold Schwarzenegger leaves a news conference at the State Capitol in Sacramento, July 1, 2009. REUTERS/Max Whittaker

California Governor Arnold Schwarzenegger leaves a news conference at the State Capitol in Sacramento, July 1, 2009.

Credit: Reuters/Max Whittaker

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SAN FRANCISCO (Reuters) - California's main debt rating was cut on Wednesday by Standard & Poor's, which said the government of the most populous U.S. state could nearly run out of cash in March -- and another rating cut might follow.

The state government's budget gap of nearly $20 billion over the next year and a half leaves it in a precarious situation, requiring tax increases or spending cuts, either of which may slow economic recovery, the agency said in a statement.

"If economic or revenue trends substantially falter, we could lower the state rating during the next six to 12 months," S&P said after cutting the rating on $63.9 billion of California's general obligation debt one notch to A- from A.

The new level is four notches above "junk" status, a level at which many investors refuse to buy debt.

"The big question is, is there any fear they will get downgraded out of investment grade (so) you may have to sell ... that's where I think it would get interesting or hairy," said Eaton Vance portfolio manager Evan Rourke.

Bond prices did not move much, though, since many expected the downgrade, he said.

S&P's downgrade was overdue because the state's revenues have been so weak, said Dick Larkin, director of credit analysis at Herbert J. Sims Co Inc in Iselin, New Jersey. "Frankly I can't understood why it took S&P so long," he said. "They could have made that decision back in September."

$1 BILLION SHORT IN MARCH

California already had the lowest debt rating of any U.S. state before the downgrade, and 39 state governments are struggling with shortfalls this fiscal year, according to the nonpartisan Center on Budget and Policy Priorities.

Many are begging for more federal funds and caught between cutting social programs, raising taxes, or both.

The housing market implosion was felt especially strongly in California, a subprime mortgage lending center. Its double-digit unemployment rate, one of the highest in the United States, is expected to endure for a year or more.

California's government resorted to issuing IOUs last year for the second time since the Great Depression when it nearly ran out of cash. Officials are scrambling to raise $1 billion for March and the shortfall could be worse in July, S&P said.

State Treasurer Bill Lockyer's spokesman Tom Dresslar said S&P's downgrade "highlights the critical need for the legislature and the governor to produce a swift budget resolution that is credible to the market."

"Standard & Poor's makes it clear the failure to act in a timely manner and with credibility threatens to further lower our GO rating," Dresslar said, adding that a further cut would hit taxpayers already paying higher interest rates than people in some emerging economies.

The cost to insure California's debt with credit default swaps is now higher than debt of developing countries, such as Kazakhstan, Lebanon and Uruguay. It costs $277,000 per year for five years to insure $10 million in California debt, compared with $172,000 for Kazakh debt.

George Strickland, a municipal bond mutual fund manager at Thornburg Investment Management said S&P still has California GOs rated too high. Moody's Investors Service has a Baa1 rating on the debt and Fitch Ratings rates the bonds BBB.

"There's another notch to go before they hit bottom," Strickland said, adding that he expects another long and ugly battle to fill the state budget's shortfall.

Governor Arnold Schwarzenegger less than a week ago unveiled a plan to balance the state's books, largely with spending cuts that he described as draconian and which leaders of the Democrat-controlled legislature sharply criticized.

S&P said "timely progress" on a budget fix would be impeded by previous reliance on one-time measures, fewer choices for one-time cuts, extraordinary reliance on federal aid in Schwarzenegger's plan, and California's unusual requirement for a supermajority of lawmakers to pass a budget.

The Republican governor's budget plan also said that while the state government faces cash challenges in March, it will have sufficient cash to repay $8.8 billion in revenue anticipation debt in May and June as scheduled.

State Finance Director Ana Matosantos along with Lockyer and State Controller John Chiang said on Monday they are working together so the state government honors its RAN debt.

Bond payments are by law a top state priority and state Finance Department spokesman H.D. Palmer said they will be honored: "Even though we've got to make some decisions in managing March we absolutely have ample cash on hand to make our RAN payments in May and June on time and in full."

Larkin said the three major rating agencies will hold off on more downgrades to California's credit rating to avoid roiling the municipal debt market, even in the event budget talks between Schwarzenegger and lawmakers drag on.

"They'll give the state an awful lot of rope," Larkin said. "For a state to go below investment grade would cast a pall on every state and local issuer out there."

(Reporting by Jim Christie, Peter Henderson, Karen Brettell and Joan Gralla; Editing by Andrew Hay, Gary Hill)

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Comments (4)
clarify wrote:
California( from an outsiders’ point of view) seem to have a utopin outlook and do not care about the practicality of their actions. This is now the end. There is no one else’s money to spend. The gov is treating it in a practical but painful manner. REALITY. He will be put down as the bad guy but the liberals will never look at themselves as the cause of reckless, needless spending over the years. They are the immature children who always get their way and now parents are asserting themselves and the children will kick and scream, but its OVER. Your state has been destroyed by greedy spenders and all their needless projects will suffer as will all the citizenry. I feel sorry for the good people and hope the anger will be toward the real bad guys, but I’m not counting on it as there are too many liberals who will blame someone else, like the juveniles they are.

Jan 13, 2010 10:57pm EST  --  Report as abuse
franwex wrote:
The reason California is in debt is simply because of its voters. The state consequently put on too many obligations when times were good, and now that times are bad it cannot pay for them. Imagine buying a car and a house and then getting laid off. Everyone wants to have nice things in their state, and most voters do not care about the cost of projects, or don’t know too much about “state budgeting”. High-speed rails, bigger freeways, prisons, hospitals. California voters approved most projects to be built without really knowing that a state CAN run out of money. This has nothing to do with being “liberal” or “conservative;” it’s simply public ignorance. Last time California ran out of money was during the Great Depression, so this is new to many Californians. I’m sure the lesson has been learnt (hopefully).

Jan 14, 2010 2:47am EST  --  Report as abuse
THeRmoNukE wrote:
Didn’t the people of California vote to oust Governor Davis in the middle of his term beause of budget shortfalls?

I remember the Governator talking about cutting the fat and wasteful spending during his campaign. How about that, another politician that wants to cut spending, but just keeps making it worse.

Read my lips: Arnold is a liar, and Californians of highly questionable intellect voted out a decent man in the middle of his governorship to put this clown into office. I guess you really do get what you deserve after all.

Jan 14, 2010 9:04am EST  --  Report as abuse
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