Posted on 07/02/2003 10:18:08 AM PDT by NativeNewYorker
July 2 (Bloomberg) -- California is the scariest place in the
U.S. municipal bond market.
The state is looking at a $38 billion budget shortfall -- a
gap bigger than the budgets of all other states except New York --
for 2003-2004. The state's lawmakers are deadlocked over what to
do about it.
This is the same state that only two years ago surpassed
France as the world's fifth-largest economy, at $1.33 trillion,
and gave Britain (at $1.4 trillion) a run for its money. Now some
Californians are talking about bankruptcy.
States can't declare bankruptcy. James Spiotto of the law
firm Chapman & Cutler in Chicago, the nation's foremost municipal
bankruptcy specialist, says so. Bruce Bennett, who helped engineer
the bankruptcy of California's Orange County, says so. John
Moorlach, who blew the whistle on Orange County's investments and
is now the county treasurer, says so.
And yet. And yet. There is an old expression about how new
ideas in public finance blow in from the West. John Hallacy, head
of municipal research at Merrill Lynch & Co., put it another way:
``Isn't California always the test case?''
States toying with insolvency isn't a good or new idea.
Try to Remember
``The posturing of no new taxes is not helpful in finding a
solution,'' Dan Heimowitz, then director of public finance at
Moody's Investors Service, told the New York Times.
A financial adviser had another take. ``They don't want to
raise taxes, that is not a viable option,'' said Thomas Hayes,
former California state treasurer. ``It will take a two-third's
vote to enact more taxes and that is not going to happen,'' he
told the Times.
They aren't referring to what's going on in California now.
They were saying that in 1994 when Orange County declared
bankruptcy, a move that stunned everyone in the municipal market.
Perhaps you remember. Here was one of the wealthiest counties
in the nation bankrupt, the result of the county treasurer's wrong-
way bets on interest rates.
This kind of thing just wasn't done. Bankruptcy was the
refuge for the municipal market's sickest cases, not the healthy
and wealthy temporarily caught up short just because they weren't
wise when it came to investments.
Lack of Will
The Orange County bankruptcy rocked the municipal market
because it went against all the rules. The No. 1 rule is that a
municipality must do everything to repay its debts. That's what
the pledge of a municipality's ``full faith and credit'' means,
when it sells general obligation bonds. Orange County had the
ability to repay its debts. It lacked the will.
California's lawmakers apparently don't have the will to pass
a budget with a little pain.
What is happening in California isn't much different from
what has been going on from coast-to-coast, although the numbers
are larger and scarier and the legislative inaction inexplicable.
Government is in the business of providing services. The more
money comes in, the more services government can provide. This is
what took place in the 1990s. The stock market boomed, people made
more money, and tax revenue swelled.
What did states do? They put aside more money in rainy day
funds. They cut taxes. They increased services. They introduced
new services.
Spending More
Here's what has happened in California, according to figures
provided by the State Controller's office.
-- Spending: $67 billion in 1997-1998, $72.5 billion in 1998-
1999, $81.9 billion in 1999-2000, $92 billion in 2000-2001, and
$96.9 billion in 2001-2002.
-- Revenue: Stock market-related personal income tax revenue
declined from $17.6 billion in 2000-2001 to $8.6 billion in 2001-
2002, and to $5.2 billion in 2002-2003.
Between 1997 and 2002, spending increased by almost 45
percent. The state's population didn't grow by 45 percent. It grew
by 8.6 percent. In 1997, 32.5 million people lived in California.
In 2002, 35.3 million people lived there.
Let's not even bring up the whole electric power crisis,
which ravaged the state in 2000 and 2001 and bankrupted its
largest utility.
We all know what has to happen next.
It's not insolvency.
It's not a debt moratorium.
It's not setting up a separate czar to run the state and make
all the decisions.
Wall Street Ready
The state has to spend less, or it has to get more money
through increases in taxes and fees.
Wall Street will help, if those in Sacramento can pass a
budget. California, which has the lowest state ratings at Standard
& Poor's (A) and Fitch Ratings (A) on its general obligation
bonds, and is tied with New York and Louisiana at Moody's (A2),
still has access to the municipal market.
In June, the state sold $1.7 billion in bonds. It paid more
to do so, on a comparative basis, than any other state -- 0.64
percentage point more than triple-A.
The only reason people haven't said more about how much more
California has had to pay to borrow is because yields in the
municipal market are so low. Even with the penalty, California
still paid only 5 percent to borrow money for 30 years.
Bad Karma
And once California lawmakers stop posturing (Republicans
want to cut spending, Democrats, who control the Statehouse, want
to raise taxes), the state will be able to sell $10.7 billion in
bonds to help cure its $38 billion shortfall.
For all its problems, California began the year with plenty
of capacity to sell bonds, ranking 20th in terms of debt per
capita, according to Moody's.
That said, California is still the scariest place in the
municipal market. I keep returning to Orange County, and what
Bruce Bennett told the Times in 1995: ``Even though the tax base
of the county is very wealthy, the county government doesn't have
unrestricted access to it.'' Some Californians might say the same
thing concerning the state.
Joe Deane, who oversees more than $7 billion of municipal
bonds at Citigroup Asset Management in New York, perhaps explained
it best: ``There's just a lot of negative karma going on out there
right now.''
These things *usually* end up with a spit-and-baling-wire solution, and folks move on to spin.
If the Dims controlled DC, it is a good bet Uncle Sugar would be picking up some of the tab. With W and the GOP in control, Davis' goose is cooked.
The county treasurer was a flaming Democrat. They liked him because of his high investment returns but little did they know he accomplished that by greatly increasing risk. The lesson is: never ever trust a Democrat with your money.
Even with the penalty, California still paid only 5 percent to borrow money for 30 years.
Not exactly true. Bond buyers do not pay state income tax on the income from these bonds. The state is really borrowing at about 8 percent, and these bonds compete for buyers in the junk bond market.
Millions of illegal aliens + welfare state = financial disaster.
Yes. Do you consider that a positive or a negative?
Perhaps they could bring Congressman Dennis Kucinich as a consultant. He did such a good job putting Cleveland into default on its obligations.
I think of it as an arbitrage opportunity. :)
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