Beneath the Surface, a Vital State Economy

The image of California in crisis is back again.

Last time, it was a confluence of earthquake, urban rioting, wildfires and recession that brought snickers from late-night talk show hosts and national magazine covers asking, “Is the California Dream Dead?”

This time, it’s the spectacle of a gubernatorial recall and a colossal budget gap causing the clucking headlines. Even the way a budget deal was reached Tuesday -- with lawmakers forced to pull an all-nighter at the Capitol, chomping on cigars and drinking Jack Daniels -- was the stuff of parody.

While the state of affairs in the Golden State is far from healthy -- especially in Sacramento -- the picture isn’t nearly as dreadful as many paint it.


Just follow the money. A peek beneath the surface shows that the financial markets are making a calm calculation of long-term strength despite short-term weakness.

Indeed, California cities looking to raise financing to build roads and facilities to accommodate their fast-growing populations are still finding “a lot of support” among bond buyers, in the words of John Fitzgerald, head of Fitzgerald Public Finance, an investment banking firm in Los Angeles that serves the state’s municipalities. “There is large demand for local issues,” he says.

One reason is that many California localities have planned prudently.

“We live within our means,” says Zane Johnston, finance manager for Tracy, a city of 65,000 that is an hour’s drive east of San Francisco. Even though Northern California still is feeling the effects of the meltdown in high tech, Tracy has weathered the storm.


A decade ago, during the last recession, “our reserve fund fell under $4 million,” Johnston recalls. “So when we got flush in the boom of the ‘90s, we stashed money” away. The fund now is up to $50 million.

Similarly farsighted was David Bass, finance manager for Lake Forest in Orange County. He sought assurance against bad times last fall.

“I knew we might need to borrow” to build roads and other infrastructure for the city of 75,000, Bass explains. “So I asked Standard & Poor’s for a rating” well in advance of the need to raise capital.

Lake Forest received its

credit rating in January, just as Gov. Gray Davis was releasing a gloomy fiscal projection that threatened to take revenue away from cities to help close Sacramento’s budget gap. Yet Lake Forest still managed to snare a double-A-plus mark from S&P;, next to the highest possible level.

The city will decide this fall what projects to pursue. And when Lake Forest does go to raise the necessary funds, it is guaranteed the ability to borrow at favorable interest rates. Most of the state’s 500 or so cities enjoy the same credit status.

Demographic Power

Even more than foresight, though, the fundamentals are what’s driving things.


“Everybody knows the economy will recover and is a great engine,” says Robin Rappaport, senior municipal credit analyst at Payden & Rygel, an L.A. investment firm. “It’s the sixth-largest economy in the world.”

The demographics alone are a powerful force. California is adding almost 600,000 people a year to its population of 35 million. And more housing is being built to accommodate that growth than was the case in earlier decades, notes economist Stephen Levy of the Center for the Continuing Study of the California Economy, a Palo Alto research organization.

Wages and per capita income are likely to grow faster in California than in the rest of the country during the next 10 years, Levy predicts.

It is just this kind of unruffled view that is bringing buyers even to the state’s general obligation bonds, on which S&P; last week lowered the credit rating from A to BBB -- one level above junk.

“There was selling when the downgrade came,” says a municipal bond underwriter at a major investment firm, “but as of Monday, institutional and individual investors have come into the market,” smelling opportunity.

In fact, California bonds are attractive in some eyes because the state’s distress is forcing it to pay a premium in interest compared with other states. But the risk that California won’t honor its debts remains minimal. “Nobody thinks default” is a real possibility, says bond dealer Marilyn Cohen of Envision Capital, a Los Angeles firm.

Municipal Precedents

Cohen and other experts cite as precedent Orange County, which declared bankruptcy in 1994 -- but never missed a payment on its bonds. In 1975 New York City went belly up, and yet it also never failed to pay interest on its debt.


So is there really nothing to worry about?

No. The problems facing the state are quite real. Parts of the economy, especially in the Bay Area, continue to suffer. The workers’ compensation insurance system is a shambles -- and stands as a sorry symbol of how unfriendly to business the state has become. Meanwhile, the just-approved budget counts on borrowing billions and billions of dollars, simply delaying the hard decisions.

Despite all this, the caricature of California toppling into the sea is way off base. The state surely will right itself because of its massive, ever-adapting, ever-growing, brain-power-fueled economy. And then the magazines will offer that other perennial headline: “California Is Back.”

James Flanigan can be reached at