State’s AAA Credit Status in Jeopardy

California officials were warned by the Standard & Poor’s credit-rating agency Monday that they must come up with a better plan to deal with the “rapidly developing (budget) deficit” or face a downgrading of the state’s highly valued AAA bond rating.

State officials cautioned that the agency’s announcement--officially placing California on its “credit watch”--does not carry an immediate cost to state taxpayers. But they conceded that if the AAA rating is lowered, the state’s cost to borrow money could increase by millions.

The development came in the wake of assessments by various state officials that California faces a budgetary shortfall of $7 billion to $10 billion over the next 18 months.

Standard & Poor’s was particularly concerned about a $1.8-billion shortfall it projects for the remainder of this fiscal year, which ends June 30.

California’s credit rating dropped twice in the last decade, once in 1980 after passage of the property tax limitation measure Proposition 13 in 1978 and voter approval a year later of strict spending limits. In 1983, two credit-rating agencies, including Standard & Poor’s, further lowered California’s rating. The rating climbed back from AA to AAA about three years later, a move that lowered interest rates the state paid to borrow money.

About 30 other states are said to be in a financial bind similar to California’s. States facing the most severe problems are in the Northeast. New York, Connecticut, and Massachusetts have all had their credit ratings lowered in recent months.

The threat to California is not immediate. Standard & Poor’s said it would give state officials several months to come up with a budget plan before taking action to downgrade its bond rating. But the firm said the credit review has “negative implications” for nearly $15 billion in state bonds already sold. Their values could fall on the expectation that interest rates on new bonds would rise.

Standard & Poor’s, in a nationwide press release, said the revenue assumptions contained in Gov. Pete Wilson’s proposed $55.7-billion budget for the 1991-92 fiscal year are too rosy.

The New York-based agency faulted Wilson and his budget advisers for assuming that a strong economic recovery would produce an extra $1.2 billion in tax revenues. Wilson’s budget assumptions, Standard & Poor’s said, are “considerably more optimistic than most forecasts of recovery” and come at a time when the prospects for a national turnaround are “increasingly uncertain.”

Unless quick action is taken, the firm said, the state faces a $1.8-billion deficit during the current budget year.

Wilson’s budget plan includes spending cuts and tax increases. Standard & Poor’s said these “could contribute to budgetary balance for 1992 and beyond.” But it cautioned that there “are few proposals . . . that will reduce the deficit for 1991.”

Wilson, after a morning news conference, said his budget was “a very responsible” spending plan that contains both tax increase proposals as well as “some very painful cuts.”

When asked about the possible credit downgrading, Wilson said, “I cannot see good reason for it.” He repeated his commitment to produce “a balanced budget” by the July 1 start of the 1991-92 fiscal year.

State Finance Director Thomas W. Hayes said he disagreed with Standard & Poor’s analysis.

“We have a history of enacting balanced budgets with prudent reserves and will continue to do so not only this year but also in future years,” he said in a statement released by his office.

Treasurer Kathleen Brown called the announcement “a warning” that state officials had better come to grips with the budget problem and develop “a contingency plan” if Wilson’s optimistic budget assumptions do not work out.

Brown said that under a rule of thumb, a drop from AAA to AA could increase interest costs of state bonds by about $2 million a year for each $1 billion borrowed over the average 20-year life of each bond. The state next year plans to borrow about $3 billion.

Other credit rating agencies said they were concerned about California’s financial situation but were not willing to go as far as Standard & Poor’s.

George Leung, managing director of public finance for Moody’s Investors Service, the biggest and oldest rating agency, said California’s budget problems are “something that concerns us.”

Leung said he believes California’s economy is fundamentally sound. “What we are concerned about is the adequacy of the steps the state is taking to contain the budget problem,” he said.

Clearly, the implication by Leung and other officials interviewed Monday is that they are expecting either a round of deep budget cuts or a substantial hike in taxes.

Assemblyman John Vasconcellos (D-Santa Clara), chairman of the Assembly Ways and Means Committee, called the Standard & Poor’s announcement “a grim warning.” Vasconcellos said through a spokesman that “the best thing we can probably do is enact a temporary sales tax increase. The worst thing we could do is further cut services.”

BACKGROUND

Ratings of state credit-worthiness are issued by three Wall Street agencies. The ratings typically range from AAA for the most credit-worthy government agencies, to B. With each fall in the rating, the government agencies generally pay progressively higher interest rates to borrow money. California bonds were downgraded twice in recent years. In 1980, the state’s rating was dropped from AAA to AA+. In 1983 it fell again to AA. The state got its AAA rating back three years later.