Discredited CA Complains About Credit Agencies (again)

Posted on July 31, 2009
Filed Under Uncategorized |

Bill Lockyer’s office (Treasurer of the state) had this to say about major credit agencies recently downgrading the state of California.

“The lower (California’s) rating is, the more (taxpayers) pay on debt service,” he said. “Every additional dollar they pay to investors is a dollar they cannot spend to educate their kids, protect their communities, clean up their environment, fight fires … all the crucial public services.”

[From California could have $15 billion shortfalls]

If this is the case, and it’s true that a lower credit rating increases borrowing costs, then why the hell haven’t the state politicians been making it a priority? We’ve been running deficits for the entire decade when you look at total spending against revenues (not just general fund expenditures) and have had to borrow more money than any other state… and now Lockyer is throwing out the familiar refrain about “educating kids”. Chutzpa.

Lockyer’s argument is essentially that California is being unfairly penalized by ratings agencies and if they would lay off the state would be in better financial condition, which of course is an argument that is just as absurd as “investors need to stop believing their own lying eyes about CA’s financial condition”. Lockyer seems to suggest that if it were not for ratings agencies the state borrowing costs would be lower.

Lockyer’s office also had this to say:

“There was actually very decent demand for California bonds in the secondary market (in the past month),” he said. “Folks continue to believe that despite the beating our reputation has taken nationally and internationally … California is a pretty sound investment.”

Actually no, investors don’t see California as a “sound investment”. The spreads on CA bonds are about 1.2%, which is double that of AAA rated borrowers and the yield on CA bonds is really high reflecting the low price the market is trading them for… because of the risk CA poses. With tax adjusted yields hitting 5% on short term notes (to put that in perspective, LA County one year notes are yielding 0.5%), CA is paying more than any other muni borrower for money, which certainly helps explain investor interest.

Investor demand is also high because the interest is high and few investors are anticipating that CA will default and if that risk looked real the calculation is that the Federal government would certainly step in. California is about 15% of the entire muni bond market and a default would not only impact every other municipal borrower but also would drive up Treasury yields so the Feds would certainly have to step in and investors know it.

Lockyer has been engaged in a long running complaint session against ratings agencies, on one hand deriding them for optimistic ratings on financial institutions (Calpers is even suing rating agencies for what they call optimistic and unreliable ratings) while at the same time complaining that these same ratings agencies are overly harsh on states and other muni borrowers. While there is much to be said about bond insurance being a hidden tax on muni borrowers, the fact is that municipal agencies do default (e.g. Vallejo, Orange County) and ratings are useful when comparing against other borrowers… in other words, ratings are essentially a measure of relative strength. At any rate, when the states complaining about bond ratings are also the most financially mismanaged states (CA, NY, RI, NJ) you don’t have much of a case.

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