Budget Plan Risky, Official Warns

State Treasurer Phil Angelides warned Friday that the $18-billion borrowing plan drafted by legislators to balance the budget is fraught with risk that could deepen California’s financial crisis.

“This is clearly an unprecedented level of borrowing,” Angelides said as he unveiled the timetable for offering the bonds to investors. He called on legislators to once and for all find a way to close the deficit without pushing it into the future.

“In the investment community’s mind, they see this budget as a reflection of a political world that is unable to come to grips with basic financial decisions,” he said.

Earlier this summer, legislators fell back on extensive borrowing after being unable to raise enough taxes and make enough cuts in government services to correct the imbalance between what the state gets in revenue and what it spends. They closed a $38-billion gap by rolling much of it over into the next five to seven years, a solution that caused the state’s bond rating to tumble to the lowest of any state in the nation.

If all the borrowing holds up in court -- and fiscal experts warn it may not -- Angelides estimates that it will cost taxpayers nearly $100 million a year for each of the next five years. Investors say the cost could be substantially more than that, because the appetite for California securities has been curbed by fiscal instability and political turmoil, especially the drive to recall Gov. Gray Davis.

The bond sales will begin as early as next month, with a $2-billion pension obligation bond offering. The money generated from the bond sale is to be used to cover the state’s contribution to the public employee retirement fund, freeing up other general fund money to pay off the deficit.

The state could also begin selling $2.3 billion in tobacco bonds by next month. That sale would involve borrowing against revenue expected from legal settlements with cigarette manufacturers. Investors have become wary of such bonds as tobacco companies run into financial problems resulting from other lawsuits, which threatens their payments to the states.

A separate $3-billion revenue anticipation loan scheduled for October is fairly routine, and will be used to help even out the state’s cash flow, Angelides said.

But an $11-billion bond sale due to begin in February will be anything but routine. These unprecedented “deficit reduction bonds” would allow the state to spread a large part of its deficit over the next five to seven years and dedicate a half-cent of sales tax over that time to pay it back.

Officials at the Pacific Legal Foundation, a property and taxpayer rights group in Sacramento, have announced their intention to file a lawsuit to stop the sale of the bonds. They say the borrowing would violate state constitutional prohibitions against carrying a deficit from one year to the next.

“The California courts have never approved anything like this,” said Harold Johnson, an attorney with the foundation. “This stretches all the precedents way beyond recognition.”

The office of the attorney general and the bond counsel for the state believe the borrowing is legal because the repayment of bonds would be reauthorized annually by the Legislature. Yet budget experts say a court victory for the state is not certain.

“This will probably be the most important lawsuit in this year’s budget,” said Fred Silva, a budget analyst with the San Francisco-based Public Policy Institute of California. He said courts have granted many exceptions to the debt clause in the Constitution, but legislators may be pushing their luck this year.

If a court struck down the deficit bonds, the linchpin of the compromise budget signed by the governor earlier this month, Silva said, the budget deficit would grow substantially and “it would be a mess.”

The state is already in court over the pension bonds. And Angelides said the litigation, filed by the Howard Jarvis Taxpayers Assn., may block the state from selling the bonds before it must make its fall contribution to the retirement fund. That would add $553 million to California’s budget problems.

Though Angelides acknowledged that the sale of all the bonds will be a formidable task, he said the state has more than $6 billion in reserve in the event any of them fall through or are delayed.

Some budget analysts are skeptical of that number. They say some of the projections in the state spending plan are overly optimistic and that reserves will quickly erode as the fiscal year goes on.

Angelides said that, despite the state’s budget problems, investors remain eager to buy California securities. He noted that California bonds have been performing well in the market since the budget deal was struck.

Investors interviewed Friday, however, said Angelides might be painting too rosy a picture. They said the state should expect to pay high interest rates.

David Blair, senior analyst at Nuveen Investments in Chicago, said a recent narrowing of interest rates between California bonds and municipal bonds with top credit ratings probably was more a function of “lack of supply in the market” than investor confidence.

At current yields, California bonds aren’t attractive in relation to higher-rated states and municipalities, Blair said.

Joe Deane, who manages a $7-billion bond portfolio for Citigroup Asset Management in New York, said there is no common sense in thinking the California bonds will rally just on the basis of “kind of a quasi-, almost, sort of balanced budget.”

He said the state would be well advised to hold off on bond issuance if at all possible until after the Oct. 7 recall election, which he called a sideshow that hurts California’s image in the investor community.

Angelides said that tax-free California 10-year general obligation bonds this week were yielding 4.48%, compared with 4.45% for taxable 10-year U.S. Treasury notes. He was implying that many investors would view the California bonds as a bargain.

“Sheer yield doesn’t mean” a thing to Deane, the portfolio manager said. An investment decision is “a combination of yield and credibility, and right now they don’t have any. I’m not a participant in California debt, and until things calm down there I don’t intend to be.”

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Halper reported from Sacramento; Mulligan reported from New York.

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Bonding for billions

Over the next nine months, the state must borrow $18.3 billion to shore up the budget approved by the Legislature this summer and close a $38-billion gap between revenue and expenses. The bonds involved are:

Revenue Anticipation Notes

Amount: $3 billion

Description: Standard short-term borrowing that keeps programs running while the state waits for tax revenue to reach Sacramento

Use of proceeds: Cash flow

Timing of sale: October

Maturity: June 2004

Tobacco Securitization Bonds

Amount: $2.3 billion

Description: Borrowing in anticipation of money from a 1998 lawsuit settlement, in which tobacco companies agreed to pay for health costs related to smoking

Timing of sale: September-October

Maturity: 40 years

Pension Obligation Bonds

Amount: $2 billion

Description: These loans will allow administrators to make the required annual contribution to state worker pensions without using money from the budget’s general fund.

Timing of sale: September-December

Maturity: Five years

Fiscal Recovery, or ‘Deficit Reduction,’ Bonds

Amount: $11 billion

Description: A linchpin of the budget agreement, this borrowing pushes last year’s debt into the future and repays it using half a cent on the dollar of existing sales tax revenue.

Timing of sale: February and April/May 2004

Maturity: Five to seven years

Source: California treasurer’s office

Los Angeles Times