Despite California’s widely documented fiscal woes, bondholders can expect to receive their principal and interest payments on time.
Gov. Arnold Schwarzenegger’s recently released $99.1 billion, 2004-05 budget proposal seeks to close an estimated $26 billion accumulated deficit and takes steps to reduce an annual structural imbalance of $14 billion.
The most widely publicized feature in the governor’s corrective plan is his March ballot initiative in which voters will be asked to approve a $15 billion-general obligation bond to refinance much of the state’s existing operating deficit. Other measures would reduce spending on transportation, education, health and social services.
Fees and tuition at state universities will rise and reforms in education and other state programs are aimed toward reducing future spending increases, keeping expenditures better in line with anticipated revenues.
Despite the record deficit California has accumulated, we believe the state will eventually find a workable solution to its fiscal problems. While the governor has proposed cutbacks and additional borrowing, there is little expectation that, in the worst of circumstances, the state would fail to meet its debt obligations.
First, no state has defaulted since the 1880s. Second, California, despite its budget woes, has one of the world’s strongest economies. If California were to be measured against the industrialized countries of the world, its economy would be ranked fifth in size. Third, despite the controversial nature of Schwarzenegger’s budget – and the partisan posturing it will surely engender – there is universal support among the state’s leaders and citizenry to meet state debt obligations. To do otherwise would undermine the governor’s very own bond proposal.
Problems caused by ‘perfect storm’
California’s budget problems were caused by a “perfect storm” of declining state revenues resulting from weakened economic performance, combined with spending increases mandated by various voter passed “propositions.”
California’s free-swinging populism has handcuffed elected officials through restrictions on tax increases, term limits and dedicated mandatory spending referendums, all tracing their roots back to Proposition 13 (limiting property tax increases) in the 1970s. Today, California’s task at budget balancing will be compounded by the various voter- passed mandates that populate California’s constitution.
While the Governor’s budget proposal may move the state toward fiscal redemption, it requires two major actions that are beyond his control. State voters must approve the proposed $15 billion deficit bond issue in March, and the state must be able to rollover $14 billion of short term notes due in June. Failure to pass the first hurdle may imperil the second.
Voters have little choice
Early polls indicate passage of the deficit bond is not assured. However, when push comes to shove, we believe California’s voters will have little choice if they are to dig themselves out of their fiscal hole.
Assuming the deficit bond issue passes, Wall Street should have little reason to not keep the state’s liquidity intact through the note rollover. The fallback position appears to be a smaller $10 billion bond issue, already approved by the Legislature during the waning days of Gray Davis’ governorship.
In this case, Wall Street will whine, but still rollover the notes. After all, California is the nation’s largest and most important state economically – one that no one wants to see fail.
