Should the U.S. bail out California?
California, always a place of fresh ideas, has a big one for Uncle Sam: Treasurer Bill Lockyer wants a federal guarantee on the massive short-term borrowing the cash-strapped state must undertake this summer.
Just as with a federally insured bank savings certificate, a U.S. backstop of California’s debt would assure investors that their money was completely safe.
In theory, that would mean the state could get away with paying a much lower interest rate on the debt -- saving California taxpayers a bundle.
Lockyer doesn’t just want a federal guarantee for California’s IOUs. He thinks the U.S. should do the same for all states, counties, cities and other municipal entities that need help getting through the recession.
This is exactly what it sounds like: a call for a major expansion of the federal bailout of the nation’s financial system -- but this time ostensibly to buttress Main Street, not Wall Street.
The populist argument is a slam-dunk. If the government can save Citigroup and American International Group, why can’t it extend a hand to California?
In terms of who’s truly deserving of help, “We think California taxpayers stack up pretty well compared with Wall Street firms,” said Tom Dresslar, Lockyer’s spokesman.
The treasurer has an ally in Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services Committee. Frank will hold a hearing May 5 as a prelude to drafting legislation that could create a federal insurance program for municipal debt.
But the idea is far from a no-brainer, even for some of the states and other municipal borrowers that an insurance program could help.
“We haven’t taken a formal position on it,” a spokesman for the National Assn. of State Treasurers said about Frank’s basic concept.
In January, the House passed a Frank bill that would have specifically authorized the U.S. Treasury to provide “enhancement” for municipal debt. But the bill never advanced in the Senate.
Historically, the federal government has avoided meddling in state and local finances. By law, the U.S. can’t even tell municipal bond issuers what they must disclose to their investors; corporate debt issuers, by contrast, face rigorous disclosure requirements under U.S. securities laws.
So if Uncle Sam were to provide a backstop for municipal debt, one obvious question should be: What’s the catch?
As the nation’s banks have learned with their federal bailout, the government can be an annoying partner -- always wanting to know what you’re doing with your money, particularly with regard to how much you’re paying workers.
I’m just brainstorming here, but . . . what advice might the U.S. have for California and its long-term fiscal challenges, in return for a debt guarantee? How about suggesting the repeal of Proposition 13?
Steve Adamske, a spokesman for Frank, said it was too early to speculate on how an insurance plan for municipal debt might be structured, including possible conditions.
Lockyer makes the point that California isn’t asking for a freebie. The state would expect to pay the U.S. a fee for debt insurance, just as banks pay fees to the Federal Deposit Insurance Corp., Dresslar said.
In appealing for help, California paints its situation as dire: With the recession slashing revenue, the state expects to need to raise at least $13 billion in July via so-called revenue anticipation notes.
The cash from the notes would tide the state over until additional tax proceeds roll in later in 2009 and 2010.
Short-term revenue anticipation notes normally are no big deal. In the past, California would get commercial banks to guarantee its notes as a comfort for investors. But Dresslar says the banks aren’t willing to provide the backstop that the state needs this time around.
And with California’s credit rating now the lowest of the 50 states, investors aren’t likely to lend at a cheap interest rate.
That’s a key point here: The state would find buyers for $13 billion in nonfederally insured notes at some interest rate -- but probably a rate a lot higher than it wants to pay.
When Lockyer sold $5 billion of revenue anticipation notes in October, the average annualized tax-free interest rate on the notes was 4%. That was a tremendous yield for investors, but a steep price for California taxpayers.
Although the Senate didn’t go along with Frank’s bill for broad-based assistance to municipal borrowers, it did join with the House to approve another form of aid: the Build America Bonds plan.
Under the two-year program, state and local governments can issue taxable bonds to fund infrastructure projects and have the Treasury pick up 35% of the annual interest cost on the debt. The idea is that the subsidy should make borrowers’ net interest cost less than what they’d pay by issuing standard tax-free bonds.
California will test the Build America Bonds concept next week, when it plans to sell up to $4 billion in taxable bonds.
But the temporary subsidy program doesn’t carry with it the “moral hazard” issue that would dog any program of permanent federal insurance for new municipal debt.
With Uncle Sam fully backing muni bonds, and presumably thus lowering state and local governments’ interest costs, the risk is that some would borrow like the proverbial drunken sailor -- and that those bingers would end up becoming burdens for U.S. taxpayers down the road.
For Frank and Lockyer, federal insurance for muni debt would fix what they believe has long been an injustice served up by the major credit rating firms: Because muni bonds historically have had a very low default rate, Frank and Lockyer assert that most muni debt automatically deserves top credit grades.
But anyone who has even a modest knowledge of state and local finances can see the long-term threats that governments face from soaring costs for worker pensions and healthcare.
Thomas Doe, head of research firm Municipal Market Advisors in Concord, Mass., said that, although the historical default rate has indeed been negligible for muni bonds, the question investors and the federal government now should be asking is, “Can you trust history?”