Bond Analysts Wave Red Flag on Proposition 218

California securities analysts are warning of confusion and problems in the municipal bond market if Proposition 218 is passed on Nov. 5 and local governments are restricted in their ability to raise taxes.

Under Proposition 218, sponsored by the Howard Jarvis Taxpayers Assn., taxes that finance local general services would require simple majority approval by voters. A two-thirds approval would be required for enactment of “special taxes” that are targeted to specific purposes.

“This could limit severely financial flexibility for many local governments and, in certain cases, leave less money available to pay debt service on municipal bond issues,” said a statement issued this week by the California Society of Municipal Analysts. “The fiscal stability and credit quality of many California local governments, as well as their ability to deliver services, could deteriorate.”

The nonpartisan legislative analyst has estimated that, in the short run, Proposition 218 would probably reduce local revenues by $100 million a year.

However, state Treasurer Matt Fong, whose representatives say he is neutral on the ballot measure, has said opponents of the proposal have overstated claims that the bond market would be adversely affected.

Fong did not identify the opponents but his criticism came Sept. 26, a day after a representative of California bond dealer Stone & Youngberg told legislative committees that Proposition 218 posed a “tremendous negative impact on not only future debt but also existing debt--issues that are out there right now in the marketplace.”

“It’s wrong for people to say the market will come crashing down or that bondholders will not be paid if Proposition 218 is passed. Political statements like that are irresponsible and negatively affect the market,” Fong said.

Jonathan M. Coupal, legal affairs director for the Jarvis organization, also dismissed as “greatly overstated” the warning raised by Stone & Youngberg.

He said the U.S. Constitution assures repayment of bonds already issued, regardless of the outcome of Proposition 218. As for future bond issues, Coupal said “any detrimental impact is wholly speculative.”

Targeting Stone & Youngberg, Coupal charged that the controversy had been “created by those who have a direct and pecuniary interest in selling and issuing bonds.”

Wall Street players also continue to weigh in. Fitch Investors Service of New York on Friday became the third bond rating house to wave a caution flag or issue a direct warning against the ballot measure.

In an analysis, Fitch said the proposal would have a “‘negative impact on municipal credit quality” of local governments in California and at least temporarily would “disrupt the municipal debt market” until its complex provisions were clarified in court.

Rating organizations such as Fitch, Moody’s Investors Service and Standard & Poor’s assign a classification to government-issued bonds based, among other things, on credit worthiness of the entity and risk to the investor. Generally, the higher the rating, the lower the interest rate will be.

Earlier, Moody’s and Standard & Poor’s expressed concern about the impact of Proposition 218, warning that its full affect probably wouldn’t be felt for years because of likely court tests.

However, the rating houses agreed that the measure would further restrict the ability of local entities to impose taxes and fees to pay off the bonds.

“This loss in flexibility is one additional factor in the possible erosion of credit quality over time, as local governments have a harder time meeting infrastructure and operating needs,” Standard & Poor’s said.

“A key risk of the [initiative] is that it could open up a number of issues of California public finance law, resulting in court rulings with unanticipated conclusions and consequences,” Moody’s said.