Moody’s Cuts Credit Rating of State Bonds

A major Wall Street credit-rating firm downgraded California’s bonds for the second time in six months Monday and said its action could have been avoided had a “political decision” by Gov. Pete Wilson not led the state into a cash crisis that has forced the government to pay its bills with IOUs.

The lowering of the rating by Moody’s Investors Service--from Aa1 to Aa--means that California will be forced to pay more in interest to issue new bonds to compensate investors for the higher risk. The move also could make it more difficult to attract investors to the state’s bonds, proceeds of which are used to build schools, prisons, water systems and other infrastructure.

“We had been warning of this since February, when we downgraded the rating to Aa1 from Aaa,” said George Leung, vice president and managing director for state ratings at Moody’s, based in New York. Aaa, the agency’s highest rating, is generally reserved for states and municipalities that have relatively small amounts of debt and manage it conservatively.

The action came as Wilson and Democrats remained deadlocked over how to resolve the state’s budget crisis, which has left the government without a spending plan six days into the new fiscal year.

A statement issued by Moody’s noted that other states have begun the new fiscal year without a budget but have not seen their bond rating downgraded. California’s rating suffered because, unlike others, the state has run out of cash and been forced to pay bills with IOUs, known as registered warrants, the statement said.

The state would not have run out of money had the government decided to borrow more in late June, when it had the chance to ease its cash-flow problems, the statement said.

That decision was made by Wilson, who insisted that the state borrow only enough to get through June 30. Wilson acknowledged at the time that his decision--which contradicted the advice of Controller Gray Davis--could lead to the use of IOUs on July 1, but said he hoped the added pressure would force the Legislature to agree to a budget on his terms.

“The threat of illiquidity failed as a lever to pressure the decision makers into a timely budget, and in fact now leaves the state with even fewer options,” the Moody’s statement said.

Leung, in an interview, said Moody’s is “in the business of advising investors, not in assigning blame.”

But he added: “It is (Wilson’s) strategy to hold the state to a short leash that has precipitated this cash crisis. That is a failed strategy.”

Wilson issued a statement blaming the downgrading on Democrats in the state Assembly, who blocked a possible compromise on the last night of the fiscal year by refusing to go along with the governor’s plan to cut as much as $2 billion from the public schools and community colleges.

“There will be no political winners in the Legislature with the continuing budget deadlock,” Wilson said in his latest thinly veiled reference to the November elections. “Assembly Democrats should take this downgrade as a warning and take action immediately because failure to do so only worsens our plight.”

Wilson’s communications director, Dan Schnur, said in an interview that the action suggested by Moody’s--borrowing more from private banks to get the state through its cash-flow crisis--would have been irresponsible.

“What they’re calling for would be deficit spending--borrowing money against money we don’t have,” Schnur said. “Ultimately, it would create a deficit situation that would have been extremely harmful not only to our bond rating but to the state’s fiscal condition.”

Moody’s said the downgrading was an attempt to address the seriousness of California’s cash squeeze and the “broader issue of the impasse, the unwillingness of state leaders to resolve serious problems.” Moody’s said the failure to erase the state’s hefty deficit “could result in further revisions to these ratings.”

Two other ratings agencies--Standard & Poor’s and Fitch Investors Service--said Monday that they plan to wait until Wilson and legislators break the deadlock and devise a budget plan. Both Fitch and S&P; have put California on notice that they might downgrade the state’s debt rating should the budget and recessionary problems persist.

However, Richard Larkin, managing director of S&P; in New York, cautioned that if California has “to continue to patch its cash-flow situation together from week to week and month to month in the absence of a budget, we may not have the luxury of waiting to see what their financial plan is going to be.”

By dropping a notch on the Moody’s scale, California gets lumped with 22 other states with the Aa rating. Nine states are rated Aaa and two others are ranked Aa1. Only seven states are rated below Aa.

The concern at Moody’s stems not only from the budget crunch but also the recession, which has hit California harder than other states. The state has lost more than 600,000 jobs since mid-1990, and nearly one-tenth of California workers are out of work. The state’s unemployment rate rose in June to 9.5%, up from 8.7% in May and far above the national rate of 7.8%.

Given the scope of the state’s cash and budget crisis--including the $10.7-billion potential shortfall over which the governor and legislators are grappling--the financial effect of the downgrading will be fairly small. Moreover, the Federal Reserve Bank’s lowering last week of the discount rate to 3% from 3.5% could more than offset the added interest costs that the state will be forced to pay.

State Treasurer Kathleen Brown estimated that the rating drop will cost California taxpayers $113 million in added interest cost over the 20-year life of $10 billion in bonds that have been approved by voters but not yet issued. The holders of $19 billion in outstanding bonds will see values drop by $209 million, Brown said.

The Moody’s rating of Aa on California’s so-called general obligation bonds addresses only those issued by the state and does not reflect on the credit of individual cities, counties and other issuers, which are judged independently.

Brown, a Democrat, said the governor and Legislature are to blame for the budget crisis. In comments to reporters, she decried the state’s “political paralysis” and said there was “no shortage of villains.”

As she spoke, the Legislature’s budget conference committee, dominated by Democrats, was completing its line-by-line review of Wilson’s proposed $40.1-billion general fund budget. The committee rejected most of the governor’s deepest cuts but was considering more than $300 million in proposed reductions for state agencies and commissions to help bridge the gap between the governor’s budget and the Democratic plan.

As the panel made cuts in the Fair Employment and Housing Agency, the Department of Housing and the Military Department--which runs the California National Guard--state Sen. Alfred E. Alquist (D-San Jose) said the committee had little choice but to make the reductions.

The alternative, Alquist said, is “dumping hungry kids out into the streets.”

The conference committee was the only scene of action Monday, as the wall of silence between Gov. Wilson and legislative leaders showed no signs of cracking. At least one Republican--Sen. Frank Hill of Whittier--said Wilson should take the next step and seek a meeting with Democratic lawmakers.

“It seems to me that when you reach the point that you’ve got a budget proposed (by Democrats) that has no taxes and no rollover, from the Republican perspective you now have a framework, that you ought to sit down and start negotiating in good faith,” said Hill, the Senate GOP’s chief spokesman on fiscal matters.

Times staff writers Jerry Gillam and Carl Ingram contributed to this story.

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