Bond Payments a Priority in California's Balancing Act

By: Dr. Jay H. Abrams
Chief Municipal Credit Analyst

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They cut spending, increased revenues and enacted one-time budget tricks to get California’s budget back in balance, but one thing remained sacrosanct during the prolonged negotiations among legislators and the governor: Bond payments will not be missed.

After weeks of negotiations, Gov. Arnold Schwarzenegger signed several bills designed to close the state’s massive $23.1 billion budget gap. The balancing initiatives were completed prior to the Legislature’s adjournment for summer recess. The largest state budget gap in the nation resulted from severe revenue shortfalls combined with social service expenditure growth amid the nation’s worst recession since the 1930's.

Investors protected

Investors in California state bonds were well protected throughout the budget crisis since the state’s constitution requires payment of debt service, just behind school funding, as a top priority. Other public services, and state employees, were not so fortunate. California’s severe cash flow shortage has required the state to issue short-term IOUs, in place of vendor payments, to tide the state over until expected revenue flows increase in October.

The new measures, which amended the existing 2009-2010 fiscal year budget, spread pain throughout the state. Enactment of gap-closing actions is made difficult by the state’s referendum process. Constitutional amendments such as Propositions 13 (1978) and 98 (1988) reduce state and local government revenue capacity while mandating funding for education.

According to the California Budget Project, an independent watchdog, the gap closing will be accomplished by $15.3 billion in spending cuts, $4 billion in advancing the date when revenues are collected, $3.1 billion in borrowed taxes from local governments, postponing state employee final paychecks into the next fiscal year, and assorted other fund shifts and similar actions.

A large number of Californians will see health services either cut or reduced.  Students in the state’s two major university systems can expect to see higher costs for their education. Courts will be closed one day a month, further clogging judicial calendars. Finally, a number of reductions to state programs are directed, but not specified, putting the burden on public employees to make hard choices.

State remained current on debt payments

California’s recent budget struggles are likely to recur until economic growth (and revenues) return to pre-recession levels. For bondholders, the picture is less bleak.  Throughout this year’s crisis, California remained current on its debt payments and maintained its investment grade rating. 

Clearly, California’s referendum process is in need of reform. By short-circuiting the give and take of the legislative process, the state will continue to find itself in a financial bind during the large swings between feast and famine that the state has historically experienced. The constitutional priority placed on making bond payments, however, continues to reward investors in the nation’s largest state.

7/29/2009