Budget Aid May Go Up in Smoke

More than $2 billion that California lawmakers were counting on to help balance the state budget is suddenly in jeopardy because a major tobacco company faces legal and financial problems.

On Wednesday, state officials announced that they may be forced to at least postpone raising the money through revenue bonds to be paid off with the state’s share of national tobacco settlement funds.

Although state officials expressed confidence that they will eventually be able to raise the money, some market watchers say that is uncertain. The state of Virginia has already called off a tobacco bond offering it had underway.

If the California bonds cannot be sold -- either because investors won’t risk buying them or because higher interest rates would make them too costly to taxpayers -- the state’s already staggering budget gap would grow to as much as $37 billion over the next 15 months. At the very least, analysts say, the latest downgrading of tobacco bonds’ credit rating will drive interest rates up, costing the state tens of millions of dollars or more in additional payments.

Assembly Speaker Herb Wesson (D-Culver City) called the situation “worrisome.”

“We want to make sure we do whatever it is we have to do to make sure the state is not at risk,” he said.

The tobacco bond market was thrown into chaos on March 21, when an Illinois court ordered cigarette giant Philip Morris to pay $10.1 billion for deceiving smokers by advertising “light” cigarettes as less harmful. The court ordered the company to put up a $12-billion bond to cover damages owed, even as it appeals.

That prompted bond rating agencies on Wall Street to warn that the company might have to seek bankruptcy protection if the collateral is not reduced.

Philip Morris has since warned it may not have enough cash to make the next scheduled payment due 46 states under a 1998 agreement that settled the bulk of the states’ health-liability cases against the tobacco industry.

That payment is due April 15 -- the same day California was originally expected to complete its sale of tobacco bonds, which are backed by these future payments from tobacco companies.

On Tuesday, the state of Virginia said it canceled a $767-million tobacco bond sale that already was underway, citing “instability” in the market because of the Philip Morris court case.

But on Wednesday, Gov. Gray Davis said California will not follow suit. He said that the state “may delay [the bond sale] a week or two weeks, but we believe the bonds are still marketable and that they will provide the funds we anticipate in our budget.”

It is up to state Treasurer Phil Angelides to decide whether to postpone the sale, and for how long. A spokesman said Angelides has not yet made a decision on how to proceed.

Republicans, however, were skeptical.

Senate Republican Leader Jim Brulte of Rancho Cucamonga said that although administration officials suggested the Phillip Morris problems were a “speed bump, not a roadblock, I’m a little more concerned about it than that.”

Most Republicans opposed using the tobacco bonds as a mechanism for balancing the budget. Some said the situation California now faces is evidence that it is too risky.

“Frankly, it was just bad business,” said Assembly Republican Leader Dave Cox of Fair Oaks.

Many bond market experts are skeptical that California can sell the planned $2.3 billion of tobacco settlement bonds until the Illinois court case involving Philip Morris is resolved.

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Times staff writer Jeffrey Rabin contributed to this report.