Official Warns of $10-Billion State Deficit

California could face a budget deficit of up to $10 billion next year unless government regulators quickly allow the state to float $12.5 billion in bonds to recover energy costs, state Treasurer Phil Angelides warned Thursday.

Voicing extreme frustration with the Public Utilities Commission, which has repeatedly delayed a series of decisions needed to clear the way for the financing, Angelides said there is now no way he will be able to sell the bonds this year.

He accused the regulatory body of continuing to fight an “energy war” that is essentially over--while losing sight of the more pressing financial crisis that lies ahead if the state comes up billions short in next year’s budget and has to make cuts in areas such as education and law enforcement.

“There is a little reality denial here,” Angelides said, “that people do not see the fiscal freight train coming and are still fighting their old wars.”

PUC President Loretta Lynch declined to respond directly to the accusations. Instead, Lynch said she still hopes Gov. Gray Davis will sign legislation allowing the state to take a different course to sell the bonds--one she believes will face fewer legal challenges and thus be both faster and cheaper.

Lynch said that the PUC has taken measures to speed up the bond sale but that it needs to follow legal procedures to avoid litigation by utilities and others. Already, she noted, Pacific Gas & Electric Co. has filed lawsuits against the PUC.

If the bonds are not sold by July 1, the start of the 2002-03 fiscal year, Angelides said, the projected $3.1-billion budget deficit will balloon to $9.3 billion. And that, he noted, is based on financial projections made before the Sept. 11 terrorist strikes dealt a blow to the economy.

Taking the possibility of softening state revenues into account, the deficit could reach $10.2 billion if the bonds are not sold--a huge gap that would take the state back to the fiscal crisis of the early 1990s, forcing such “draconian action” as large cuts in important programs or massive tax increases to balance the books, he said.

“The irony about this bond sale is that Wall Street is ready for it. We have the lowest interest rates in 50 years,” Angelides said, referring to the improved market for bonds since the terrorist attacks, which have led many to opt for more conservative investments. “If California government could stop its infighting. . . .”

The proposed bond sale is intended to raise money that would repay California taxpayers for budget outlays used to avert blackouts this year and in late 2000.

Faced with energy shortages and spiraling costs, California entered the power-buying business last winter. It has spent about $8 billion in taxpayer money to buy electricity for customers of the state’s three large private utilities.

The utilities amassed huge debts and could not afford to continue buying power because they were forced to purchase expensive electricity on the open market for far more than they could charge their customers under a state rate freeze. One, Pacific Gas & Electric, has since gone to U.S. Bankruptcy Court, while another, Southern California Edison, is in danger of being dragged there by creditors.

Under a plan approved by Davis and legislators, the state is to be reimbursed for the power purchases through what would be the largest municipal bond issue in American history. The bonds, in turn, are to be paid off by customers of the private utilities as part of their monthly bills.

However, that plan has run into a series of regulatory roadblocks at the PUC, largely because it would lock in a set of long-term power contracts the state signed with energy companies during the power crunch that critics consider outrageously expensive.

The state signed the contracts, which total more than $43 billion, to help stabilize the power market and secure a steady supply of electricity while the utilities regained their financial footing. But the market prices for power have dropped and now are lower than the costs of many of the contracts.

Angelides initially said he expected to sell the bonds last spring. But because they are entwined with the power contract debate, the PUC has postponed a vote on several actions needed to sell the financing on Wall Street.

Among the actions that the PUC is being asked to take is one that would force it to relinquish most of its authority to set utility rates. That is because the bonds are intended to reimburse the state for its power purchases, so the PUC would be required to rubber-stamp the existing contracts and pass the bill on to consumers.

Some of the PUC commissioners are extremely reluctant to do that, despite considerable pressure by Davis and other state leaders.

Siding with Lynch, Senate President Pro Tem John Burton (D-San Francisco) entered the debate and succeeded in passing legislation that would separate the two issues by setting up a new mechanism to repay the bonds.

But the bill, SB 18xx, is opposed by Davis, whose staff has predicted a veto, and Angelides, who says he could not sell bonds under its terms.

Angelides declined to issue any more estimates on when he could sell the bonds until the PUC does its part.

Even if the PUC were to act soon, it would probably be months before any bonds could be sold, Angelides said, because the utilities are expected to contest the state’s plan to devote part of all utility bills to debt repayment. Angelides has indicated that he thinks those issues could be resolved within 60 days of the PUC’s approval.

Lynch said Thursday that she thinks Angelides has underestimated how long it will take to resolve those challenges.

“The idea that the litigation schedule would be quick does not reflect the reality of Bankruptcy Court lawsuits [by PG&E;], federal lawsuits or state lawsuits,” she said. “My primary disagreement with the treasurer is that you must account for litigation risk if you go down [the current] path.”

Tensions have mounted in recent weeks between Angelides and the PUC president.

In a Sept. 18 letter to Angelides, Lynch accused JP Morgan, the firm Angelides hired to spearhead the bond deal, of having a conflict of interest. Angelides’ office fired back a letter of its own denying the charge.

Lynch accused JP Morgan of bias because a JP Morgan subsidiary, Morgan Guaranty, was the main lender on a $4.3-billion bridge loan the state took out to help cover power costs.

Morgan Guaranty recently threatened to declare the state in default if it changed the terms of the bond deal, which is supposed to pay off the loan.

Thus, Lynch said, JP Morgan cannot advise the treasurer objectively about whether the new approach she favors for the bond deal is better.

“At the same time that Morgan Guaranty is threatening to put the state into default on a $4-billion obligation, its affiliate, JP Morgan, is advising the state concerning the $12.5-billion financing,” Lynch said.

“It seems clear that JP Morgan cannot give independent, disinterested advice on the relative benefits and risks of the different financing plans that are currently under consideration.”