Sympathy in muni market for Calif. budget veto

SAN FRANCISCO (Reuters) - California Gov. Arnold Schwarzenegger's threat to veto a budget bill approved by state lawmakers is winning support in the municipal debt market despite added uncertainty over when the most populous U.S. state will have a spending plan in place.

California's budget for its current fiscal year is more than two months overdue, a record for state officials notorious for taking their time in crafting and passing spending plans.

Lawmakers approved their bipartisan budget early Tuesday morning and Schwarzenegger said later in the day it was not up to snuff and that he would veto it.

"It's not a fiscally responsible budget," Schwarzenegger said, instantly drawing fire from Democrats who control the legislature and its Republican minority.

Lawmakers from both parties told the Republican governor to prepare for an override vote of his veto, well within their reach as they passed the budget bill with votes to spare.

Speaking at a Bond Buyer conference in San Francisco on Wednesday, Standard & Poor's managing director Steve Zimmermann said the battle, coming against a backdrop of turmoil on Wall Street, is unprecedented even by California standards.

"This takes the cake," Zimmermann said.

Even so, he said a veto could force lawmakers to grapple with the root causes of California's "structural" budget woes from which its routine shortfalls stem.

Credit rating agencies routinely criticize California's elected officials for failing to permanently balance spending and revenues. That holds down the state's credit rating, which raises its borrowing costs.

"We would hope that the delay could be used in a positive manner ... that there could be progress on the structural deficit," Zimmermann told Reuters on the sidelines of the conference.

DEBATING BUDGET FUNDAMENTALS

Schwarzenegger plans to veto a difficult compromise for California's ideologically driven legislature.

The budget bill closes a $15.2 billion shortfall and sets $104.3 billion in spending for the current fiscal year that began on July 1. It denied Democrats the higher taxes they wanted, blocked deeper spending cuts urged by Republicans and backed Schwarzenegger's proposal to allow the state to borrow against the future revenues of its lottery system.

The bill would also keep a reserve, expand the governor's power to cut spending and establish a rainy day fund.

But Schwarzenegger said the bill's provisions for preventing lawmakers from raiding the rainy-day fund in lean times were weak, underscoring the legislature's unwillingness to alter the state's budget process.

"To me, the most important thing ... is the reform of the system," Schwarzenegger said on Tuesday.

That resonated at the conference, where many said lawmakers had passed on facing up to the fundamental financial challenges facing California, the biggest issuer of U.S. municipal debt.

"Legislators acted strongly in accordance with the interests of their individual districts and that affected their ability to forge a budget with a permanent solution to the structural deficit," said Edward De La Rosa, president of regional investment bank De La Rosa & Co.

David Crane, a top economic adviser to Schwarzenegger, said a veto would send a strong message about the need for change in the state's budget process even if lawmakers override it. "You've got to establish a principle," Crane said.

California can afford to debate that for a while longer as it has been socking away revenue and withholding payments to vendors pending a budget taking hold, Schwarzenegger budget architect Michael Genest told the conference by telephone.

Additionally, investors holding California debt can rest easy as a top financial priority for the state is paying its debt, which it must do even without a budget in place, said Genest, director of the state's finance department. "We will our make payments on our bonds," he said.

(Editing by Diane Craft)