Judge Blocks Sale of California Bonds

A judge on Tuesday blocked as unconstitutional the state’s plan to borrow nearly $2 billion for employee pensions, throwing the fragile budget out of balance and threatening possible cutbacks and new taxes that legislators had tried to avoid.

The pension bonds were part of more than $15 billion in borrowing lawmakers relied on to balance the budget. Most of that borrowing involves new techniques that critics say run afoul of provisions in the state Constitution that ban borrowing over several years to pay routine government expenses.

The ruling, if upheld on appeal, could threaten to unravel much of the budget passed this year by undermining the authority of the state to make any such bond sales to keep the budget balanced.

The Howard Jarvis Taxpayers Assn. filed the suit against the state, hoping to stop the bond sale on grounds that it violates a constitutional provision, drafted in 1849, that prohibits borrowing more than $300,000 from one year to the next to cover routine expenses.

Sacramento Superior Court Judge Thomas M. Cecil blocked the bond sale in a preliminary opinion issued orally Tuesday afternoon, saying the state had not made a persuasive case that the borrowing is structured in a way that does not violate the constitution.

“This is a significant victory for taxpayers,” said Jon Coupal, president of the Howard Jarvis Taxpayers Assn. “The constitution says today’s politicians can’t spend tomorrow’s money -- not without voter approval.... We have never had this kind of bond before and it would simply put Californians and their children into debt.”

Hilary McLean, a spokeswoman for Gov. Gray Davis, said the administration has asked the court to hear an expedited appeal.

McLean acknowledged that if the ruling stands, the $8-billion deficit that is already anticipated for next year could grow by as much as $2 billion.

“We are going to do our best to keep all the pieces of this budget moving forward,” she said, defending the bonds as an appropriate budget-balancing technique. “This was an extraordinary year in which the state was facing an unprecedented shortfall. We had to think outside the box in terms of how to address it. The borrowing was supported by both sides of the aisle.”

Officials from the state attorney general’s office, which represented the state in this week’s trial, said they are declining to comment on the ruling until a written opinion is issued. Budget experts say the courts have been inconsistent in interpreting the debt provision of the Constitution, which has been little changed since it was drafted.

The state had argued that another provision in the Constitution allows the state to borrow to make a payment that it is legally obligated to make, in this case the payment to the pension fund. But the judge sided with the Jarvis attorneys, who argued that the state was really planning to use the loan to free up funds for other expenses and to avoid spending cuts in dealing with a record shortfall.

The ruling probably will energize the plaintiffs in another lawsuit expected to be filed today, which cites the same provision in the Constitution in challenging a much larger borrowing that was the linchpin of the budget deal worked out in the Legislature. State fiscal experts were already anxiously anticipating that complaint, to be filed by the Pacific Legal Foundation, when the pension bond ruling was issued Tuesday.

“It’s an arcane but very interesting public finance problem the state is faced with,” said Fred Silva, a budget analyst with the Public Policy Institute of California. “The legal and public finance communities have constructed a whole series of legal mythologies about how to avoid the debt clause.”

Silva said he expects the case filed by the foundation to result in a “landmark ruling” in which the courts either reaffirm the 150-year-old debt clause and limit borrowing by lawmakers, or weaken it and give legislators carte blanche to push deficits out several years.

At issue in that case is $10.7 billion in “deficit bonds” the state plans to sell to pay off the deficit accumulated through this past June.

California taxpayers would pay back the bonds over the next five to seven years through existing sales taxes. If the court decides those bonds are illegal, the budget passed this year would come close to collapsing and service cuts or tax hikes would have to be swiftly enacted to keep the state from going into financial freefall.

“If the courts put further restrictions on borrowing, they would have to get much more serious about budget making,” Silva said.

Most budget analysts agree that the state probably could absorb the loss of pension bond savings and deal with it in next year’s budget. But if the other bond sale falls through, Wall Street could come down hard on the state, and even cut off its ability to borrow.

Lawmakers say the deficit bonds do not violate the Constitution because they will have to vote to approve the repayment to bondholders every year. They argue that means this year’s Legislature is not constraining future lawmakers.

The lawsuit says the point is moot because future lawmakers will have no choice to approve the payments because the alternative would be an economically devastating default.

The complaint likens the annual vote to “kabuki theater -- a ritual play with a preordained outcome.”

“It’s a blatant violation of the debt limit,” said Harold Johnson, a lawyer for the foundation. Johnson said if the courts permit the borrowing, “Sacramento will be embarking on an era of deficit financing in reckless imitation of Washington, D.C.”

The courts have been inconsistent in enforcing the debt clause.

Exceptions have been made since the 1930s to allow for “bridge loans” that the state uses to get from one fiscal year to the next. Such loans were routine during the budget crises of the 1990s and 1980s.

The pension bonds and the deficit bonds, however, go far beyond two years.

Both loans would last at least five years and total substantially more than the state has borrowed in the past.

According to Silva, when borrowing has been used to balance the budget, it traditionally has amounted to no more than 4% of state general fund spending. In this year’s budget, it would be 21%.

Richard Cunningham, a professor at UC Hastings College of the Law, says the courts are in an awkward position when asked to enforce the 19th century debt limitation, especially when it could cause the entire state budget to unravel.

“The basic thrust was from a different time,” he said. “Using those provisions to govern modern practices has become difficult.”

Yet other experts say the law is pretty straightforward. But they add that whether judges have the stomach to enforce it is another issue.

“The law is clear,” said John Ellwood, a professor of public policy at UC Berkeley. “It seems there is an intent for the state not to borrow. But what bright people write for rule, other bright people find their way around.”