California Watch: Will California Default on Bond Debt in 2010?
Written by Chris H. Sieroty
LOS ANGELES (MNI) - As 2009 comes to a close, California's economy remains severely weakened by the effects of almost two years of recession.
Economists predict that 2010 won't be any better, as the state faces a $20.7 billion dollar budget deficit, some 60-plus legislators seek re-election or look to switch houses and talk of the state defaulting on its debt obligations has sent legislators and public officials behind closed doors to discuss the ramifications.
Not to mention, voters next year will chose a new governor to replace termed-out Gov. Arnold Schwarzenegger. In 2009, lawmakers and the governor labored for much of the year to close $60 billion in deficits, using budget tricks, cutting programs and raising some taxes.
With many of their ideas either having been exhausted, including borrowing local tax revenues, or state employee furloughs that have been challenged in court by labor unions, the pressure of the election will compound the process of approving a new state budget by June 30.
California budget law, which requires a two-thirds approval in both the Senate and Assembly, has lead to gridlock in nonelection years. To reach the two-thirds required, the majority Democrats must get approval by all of their members, while attracting three Assembly Republicans and two in the Senate.
"Lawmakers are looking for anything they can do as the recession has put a huge hole in their budget," Jack Kyser, chief economist with the Los Angeles County Economic Development Corp., told Market News International. "The economic recovery in California will be a slow next year before getting better in 2011."
Kyser cautioned that the threat of the state defaulting on its billions of dollars in bond debut has become a distinct possibility. As of Dec. 1, California had $83.5 billion in long-term bond debt, with most of the debt, $64 billion, in general obligation notes, which are financed by the state's general fund.
"There is no provision for a state to go bankrupt," Kyser said. "I don't think anyone really knows what will happen or even if the state will go into receivership if it does default. I can tell you this, officials are looking at all the (current) laws."
He also warned that if the state defaults it would "freeze the market immediately for any government debt coming out of California."
Bill Watkins, executive director the Center for Economic Research and Forecasting at California Lutheran University in Thousand Oaks, Calif., agreed and urged state officials to begin discussions with the Obama administration and the Federal Reserve in case California defaults on its debt.
"In my opinion, California is now more likely to default than it is to not default," Watkins wrote in an economic forecast released Dec. 16. "It is not a certainty, but it is a possibility that is increasingly likely."
In his report, Watkins argued said that if lawmakers and the governor cannot draft an "honest balanced budget," they must prepare a worst-case scenario plan for a default.
"They need to work with federal government and Federal Reserve Bank officials to insure a coordinated plan to limit damage to financial markets," Watkins said.
In a statement, Tom Dresslar, spokesman for State Treasurer Bill Lockyer, dismissed Watkins report as nothing more than "irresponsible fear-mongering with no basis in reality." According to the state Constitution, tax revenue must go first to pay education expenses and second for debt repayment.
Kyser said even if the state doesn't default on its debt, there is also the real possibility a "couple of smaller cities" will file for chapter 9. He said cities throughout California are being driven to insolvency due revenues taken by the state to balance its budget, declines in retail sales and property taxes, and growing pension obligations.
On May 23, 2008, the city of Vallejo filed a case seeking bankruptcy protection and the adjustment of its debts under chapter 9. The plan examined three scenarios that look five years into future. One continues current service levels; a second makes further cuts to the balance the budget, and a third option makes cuts and institutes a new city tax.
Since the bankruptcy filling, the city has shuttered fire stations and cut funding to senior centers, libraries and public works. It is also in the process of reworking it's contracts and future pension obligations with city workers, firefighters and police officers.
Meanwhile, Lockyer said the state could see its debt service costs nearly double to more than $10 billion in 2020. In a presentation earlier this month to lawmakers, he said general fund debt service on outstanding bonds, authorized but unissued bonds and proposed water bonds is set to peak in fiscal 2020 at $10.45 billion, compared with a current level around $6 billion.
Moody's Investors Service rates California's general obligation debt at Baa1, or three notches above junk status. Standard & Poor's rates it at A, or sixth-highest investment grade. Fitch Ratings rates it at BBB, or two notches above junk, according to the state treasurer's office.
With California facing a $20.7 billion budget shortfall, Schwarzenegger is expected to call for deep cuts to transit programs and appeal to Washington for billions of dollars in aid. The Los Angeles Times reported on Dec. 23 that the governor will seek $8 billion in aid from Washington to help the state close its deficit.
If the governor is unsuccessful, The Times reported that he'll propose eliminating the state's in-home health care program, a welfare program and eliminate tax breaks for corporations that were recently approved by the Legislature. The governor is scheduled to unveil his budget proposal early next month.
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