Wall Street Warns of Credit Downgrade

Wall Street stepped up its pressure on California lawmakers Wednesday to break their impasse and complete a budget, warning that they are poised to take actions that could cost the state hundreds of millions of dollars if a resolution is not reached soon.

Moody’s Investors Service put the state on notice that its credit rating could be downgraded within 90 days. Such a downgrade, according to state officials, would cost California more than $400 million in increased borrowing costs. The state already has the lowest credit rating in its history, and is rated lower than every other state in the country.

As the news arrived, Gov. Gray Davis implored lawmakers to work harder to find common ground. “I can’t say too strongly how important it is for people to stop whatever else they’re doing and focus their energies on passing this budget,” Davis said. “A delay is not only troublesome, it could be financially dangerous.”

Borrowing Suggested

The warning from Moody’s came as major banks suggested that there may be ways California could borrow to pay off part of its deficit without raising taxes -- a point that Republicans have argued for weeks. Davis and other Democrats have insisted that the only way California could finance the deficit and avoid sweeping program cuts was with a half-cent hike in the sales tax.

One scenario raised in recent days by Finance Director Steve Peace and others involves a swap of revenues between state and local governments: The state would borrow money to finance part of the deficit and pay off the loan by keeping a half penny of existing sales taxes that now go to cities and counties. In turn, the state would give local governments the equivalent amount in property taxes that, by law, now can go only to state coffers.

The state would have to make roughly $2 billion in additional program cuts, however, to make up for the lost property tax revenue. So far, that proposal has failed to gain traction among the Democratic leadership. But one banker who spoke on the condition that he remain anonymous said it is a solution his institution would participate in grudgingly. “That would only solve their problem for a year,” he said. “A new tax would be best.”

The new flexibility by the banks didn’t help bring the two sides any closer to resolving their differences over how to close California’s $38-billion shortfall.

“We don’t want to do a ‘get out of Dodge’ budget,” Assembly Speaker Herb Wesson (D-Culver City) said, by rolling over the deficit without new taxes.

Democrats again warned that the Republican budget plan -- calling for substantial new spending cuts but no new taxes -- would force 100,000 children scheduled to begin kindergarten in September to wait another year, the equivalent of closing down UC Berkeley and a major Cal State campus, and the release of 20,000 inmates from prison.

That plan will be voted on by the Assembly on Sunday. As Assembly members wait for legislative staff members to turn the Republican plan into bill form, the state Senate will meet this morning to debate a list of billions of dollars in spending cuts at the behest of Republicans.

The floor action is considered largely a show that will not result in any meaningful progress -- similar to what Democrats did last week -- as legislative leaders try to hash a deal out in private.

While they do, Californians will begin to feel the effects of the stalemate. As a result of the state not having a budget, four highway rest areas will be closed in Mendocino and Trinity counties over the holiday weekend.

The rest stops appear to be the first casualties of there being no budget, but those casualties will quickly become more serious as the weeks wear on. Roughly $1.5 billion in monthly payments to local schools, colleges, universities and transportation projects have been stopped.

Caltrans Director Jeff Morales said that if the deadlock continues into mid-August, his agency could be forced to shut down its highway construction program. That would delay work on an array of projects, including resurfacing of the Long Beach Freeway, building carpool lanes on the San Diego Freeway in West Los Angeles, and awarding a contract to begin work on a $300-million freeway interchange in Riverside County.

“Some in the Legislature want to act like there aren’t any real impacts” of the budget deadlock, Morales said. “But there very well could be an impact and a big one.”

Lasting Consequences

While that money will begin flowing again when a budget is in place, a credit rating downgrade could have more lasting consequences. “It would send the wrong message to investors across the country,” said state Treasurer Phil Angelides, “one that could do lasting damage to California’s economy and its reputation in the financial markets.”

Moody’s cautioned investors that complicating the budget process this year is the effort to recall Davis from office. The firm warned that the political situation in Sacramento has led to an “increased risk that the state may not be able to reach consensus on a budget prior to exhausting its cash resources.”

The state is currently operating entirely on borrowed money from an $11-billion bridge loan that was taken out last month. Those funds are expected to run out by the beginning of September, and if no budget is in place by then, many government services could grind to a halt.

Another major Wall Street credit rating agency, Standard & Poor’s, placed California on a negative credit watch, also warning that a downgrade could be imminent.

Times staff writers Peter Nicholas and Nancy Vogel contributed to this report.