The controller’s office in August published an audit of the account that collects tax revenue generated from both a temporary tax on annual incomes of $250,000 or more and a quarter-cent sales tax and then disperses the funds to K-12 school districts, charter schools and community college districts.

With the exception of a $59.7 million accounting error the Department of Finance made when transferring funds (but is set to be corrected in an upcoming adjustment), the program was deemed to have used and accounted for the revenue appropriately.  

Still awake? Here’s some background

The Education Protection Account was created to ensure the money is used as intended — meaning to make it so lawmakers couldn’t raid education funds for other purposes — when voters approved Prop 30 in 2012. The audit was one of several accountability provisions.

The audit noted that the $59.7 million error did not affect funding to schools because of another law (Prop 98), which guarantees a certain level of education funding. The Department of Finance told the Controller’s office the error did not hurt schools because the Prop 98 guarantee was met through other accounts.

The fact that the guarantee was met regardless of the error raises questions about the need for Prop 30. But a spokesman for the Department of Finance said Prop 30 has “provided a direct benefit to schools” since it provided additional revenue streams and increased the amount of the Prop 98 contribution.

And while $59.7 million is a lot of money, it’s only a fraction of how revenue much Prop 30 has generated. Since its inception in 2012, it’s estimated to have generated around $31.2 billion.  

Why is CalWatchdog telling me this?

In April, CalWatchdog discovered the Education Protection Account had not been audited, despite the fact that voters are set to consider a 12-year extension in November (it’s now called Prop 55, and the extension is coming two years early).

Prop 55 would only extend the income tax provision, while the sales tax provision will expire in two years.

Why audit this obscure account and not how the schools are spending the money?

Auditing this account is important because it verifies that lawmakers (or anyone else for that matter) weren’t dipping into Prop 30 funds. The audit could also catch something like a $59.7 million accounting error.

And other audits have been done. There’s actually plenty of audits of the different school districts, charter schools and community college districts located on the controller’s website.

Isn’t more education funding a good thing? Seems like a no-brainer.

The Prop 30 and Prop 55 debate has never really been about the need for more education funding. Instead, it has to do with the source of the funding. 

Many experts, including Moody’s, Standard & Poor’s and Gov. Jerry Brown’s budget, argue the state is too reliant upon income tax revenue from top earners, mainly because of its volatility.

In fact, nearly half of the state’s revenue comes from the top one percent of earners (approximately 150,000 individual tax filings). Critics of Prop 30 and Prop 55 say these measures only perpetuate the problem.

Also, Prop 30 was billed as a temporary tax. But if it Prop 55 passes, it would extend the program until 2030, which critics say is not “temporary.”

Of course, if voters down Prop 55 in November, the program will expire in 2018. There would certainly be a loss of revenue for schools (and healthcare), but Brown said he’s prepared to proceed either way.  

But the honeymoon could be over for millions of Southern California residents served by municipal utilities. Moody’s Investors Service warns they will be hard-hit by the state’s latest edict on increased use of renewable energy to supply electricity:

On Oct.. 7, Gov. Jerry Brown signed a bill requiring all California utilities to generate 50 percent of the electricity they sell to retail customers from renewable energy by 2030. The legislation will be credit negative for municipal utilities if ratepayers balk at higher prices that come with the transition to renewable energy from coal-fired generation.

 

Municipal electric utilities in Southern California would be particularly affected given their reliance on coal-fired generation. Coal-fired generation has historically supplied cities like Los Angeles and Anaheim with more than 40 percent of their electricity. In contrast, Northern California cities such as San Francisco and Sacramento derive all of their electricity from sources other than coal such as solar, hydroelectricity and natural gas.

 

The Los Angeles Department of Water and Power and other Southern California municipal utilities have thus far managed the shift to other sources from coal without major ratepayer protest, allowing them to increase rates and maintain a sound financial performance. But Los Angeles ratepayers are facing a likely 3.4 percent annual water and power rate increase over the next five years to help support the further transition to cleaner energy.

 

For utilities, the Clean Energy and Pollution Reduction Act of 2015 increases the percentage of electricity coming from renewable energy to 50 percent by 2030 up from the current 33 percent by 2020. We expect the utilities will meet the 33 percent requirement. However, ratepayer affordability and technical challenges will become increasingly difficult as utilities reach towards the more significant 50 percent renewable standard.

Infrastructure costs also likely to buffet ratepayers

Moody’s says another factor could also yield future rate shocks:

[Municipal] utilities will face another major challenge in whether the transmission grid can adequately handle the intermittent renewable resources that will begin to dominate California’s power supply mix. LADWP benefits from owning and operating its transmission system and has variable resources such as a pumped storage facility and gas-fired units to balance the system. The city of Anaheim recently added the Canyon natural gas fired unit and Southern California Public Power Authority financed the Magnolia unit in Burbank to help compensate for shortfalls in solar or wind energy. In the long term, the need to successfully integrate more renewables into the grid will likely require similar additional capital investment.

But while customers of the region’s two giant investor-owned utilities — Southern California Edison and San Diego Gas & Electric — won’t be as hard hit by the latest state edict, they will also pay unique bills in coming years not borne by customers of municipal utilities. Unless a California Public Utilities Commission decision is overturned, customers of the two utilities will pick up 70 percent of the $4.7 billion cost of shuttering the broken San Onofre nuclear power plant. SCE owns 80 percent of the plant, SDG&E 20 percent.

The year before Garcetti ascended from council president to mayor in 2013, the city adopted a new retirement tier for civilian employees hired after July 1, 2013 that lowered maximum pension benefits to 75 percent from 100 percent of final compensation. It also limits retiree health care to the employee, excluding dependents. Projected savings over a 30-year period are expected to be $4 billion, with the majority of savings in out years.

 

Strides made by the city include significant progress toward reducing fixed cost burdens for pension and other post-employment benefits such as retiree health care, according to a Moody’s Investors Service report in December.

 

The rating agency affirmed the city’s Aa2 general obligation bond rating in November and upgraded the city’s outstanding real property and lease-backed debt ratings to A1 and A2 from A2 and A3, respectively.

The 2015-16 spending plan estimates that pension and other retirement benefit costs will be $1.077 billion — just under 13 percent of the city’s total spending. That’s a vast increase over pension costs from 15 years ago. But the rise has stabilized, and Santana told reporters that the pension fund for city firefighters would be 92 percent funded by 2020 — a far better figure than in most California cities.

Unions counted on to make concessions

But there are reasons to wonder if the sunny speeches Garcetti has been giving about Los Angeles City Hall’s future are too optimistic. The first is that the city budget will balance in the fiscal year starting July 1 only if Garcetti and Santana win new concessions from public employee unions. The spending plan “assumes that about 20,000 city workers will agree to no raises and many will pay a bigger percentage of their health care costs, but talks with city employee unions have dragged on since their contracts expired last year,” the Daily News reported.

This will be tough to swallow for non public-safety unions, given that police won a four-year, 8.2 percent raise this spring, and given the United Teachers Los Angeles’ success in securing a 10 percent, two-year raise from the Los Angeles Unified School District in April.

The second, much bigger problem is downbeat expectations for the city’s private-sector economy. Garcetti and other city leaders are counting on the local economy to finally begin a strong recovery at a time when pessimism in elite circles has never been higher.

The Los Angeles 2020 Commission, consisting of powerful figures from in and out of government, issued a report in December 2013 that warned of chronic stagnation without sweeping changes:

As the result of two decades of slow job growth and stagnant wages, 28 percent of working Angelenos earn poverty pay. If you add those out of work, almost 40 percent of our community lives in what only can be called misery. The poverty rate in Los Angeles is higher than any other major American city. Median income in Los Angeles is lower than it was in 2007.

 

When it comes to job creation, Los Angeles has not kept pace with the nation or other cities. Our unemployment rate is among the highest for any major city. This is not just a consequence of the Great Recession. We have lagged behind in each of the three business cycles since 1990. Los Angeles is the only one of the seven major metropolitan areas in the country to show a net decline in non-farm job employment over the last decade.

 

Activity in most of our key economic sectors is flat or in decline. We have repeatedly ignored or fumbled opportunities in one of this era’s major growth industries, the intersection of science and engineering — a field where our university-based intellectual capital ought to make us a leader. With the closure of Boeing’s plant in ‡Long Beach, there is no longer a large-scale aircraft, space vehicle fabrication or assembly facility left in the area.

Only key policy change: Much higher minimum wage

Garcetti and other leaders welcomed the report and acknowledged the challenges facing the city’s private sector. But the most significant major policy change since the report’s issuance came just this week, when the City Council approved increasing the minimum wage within city borders to $15 an hour by 2020.

The sharp increase was opposed by business interests, who warned it would make the city’s business climate even worse.

The nearby photo shows the recent demolition of a 160-foot water tank tower at Edwards Air Force Base northeast of Lancaster. Could it be a prophetic image for Southern California’s future?

The Associated Press reported the area’s regional water supplier, the Metropolitan Water District of Southern California, could be without reserves by early 2016.

The MWD supplies water to 19 million people in cities in six counties in Southern California: Los Angeles, Orange, Ventura, Riverside, San Bernardino and San Diego.

This stark news is based on the announcement that the MWD already has drained two-thirds of its backup water supplies.

In May 2013, the MWD announced its reserves of 2.6 million acre-feet of water were “the fullest they’ve ever been.”  Going into the 2014 water year, MWD said it had adequate water reserves even after two consecutive prior dry years. But the long drought now has parched reserves.

MWD storageoOverview

The MWD mainly depends on its 800,000 acre-foot Diamond Valley Lake reservoir in Riverside County for backup water supplies in the event of drought or emergencies. As of Sept. 22, current storage at Diamond Valley Lake was 401,000 acre-feet, or 51 percent of capacity.

Other MWD storage reservoirs are:

• Lake Mathews near the city of Riverside. It has has 182,000 acre-feet of storage capacity. And as of Sept. 22, it had 59,194 acre-feet of current storage, or 33 percent of capacity. Lake Mathews is where water from the Colorado River is stored in Southern California.
• Lake Skinner Reservoir near Rancho California. It has a total capacity of 44,000 acre-feet of water and was in better shape with 33,854 acre-feet in current storage, meaning 77 percent full.

MWD groundwater storage resources

MWD also has 350,000 acre-feet of potential water storage capacity in the Arvin-Edison Groundwater Storage District in Kern County.

There also are about 437,889 acre-feet of potential groundwater storage arrangements that the MWD holds in scattered water basins around Southern California.

The MWD also has arrangements with nine of its member water districts to store water in local groundwater basins.  This is called “conjunction use.”  As of July 21, 2013, about 67,400 acre-feet of water was held in these groundwater banks.

However, how much of MWD’s groundwater storage supplies may be available given the massive loss of groundwater due to evaporation during the 2014 drought remains to be seen.

Lake Mead storage

Instead of storing it in local reservoirs, the MWD also banks some of its allocation of Colorado River water in Lake Mead.  About 280,000 acre-feet of its 330,000 acre-feet of stored water may be withdrawn by the end of the “2014 water year,” which ends on Sept. 30.  About 50,000 acre-feet is available for carry-over into 2015.

North of Los Angeles, the state of California has three reservoirs where it stores water from the Sacramento Delta. The situation as of Sept. 23:

• Castaic Lake, with 325,000 acre-feet of storage, was at 36 percent of capacity.
• Pyramid Lake, with 171,000 acre-feet of water storage, was at 94 percent of capacity.
• Lake Perris in Riverside County, with 131,452 acre-feet of storage, was 43 percent of capacity.

Grand total storage going into 2015

Excluding uncertain groundwater storage levels, as of Sept. 2014, MWD has about 494,048 total acre-feet of water in surface water reservoirs going into 2015, according to CalWatchdog.com‘s calculations.

There are also about 384,264 acre-feet of water parked in federal and state reservoirs in Southern California.  Estimated total carry-over water going into 2015 is about 878,312 acre-feet, excluding groundwater storage.

All totaled, this would be enough water for about 5,269,872 people out of MWD’s 19 million-person customer base, or water for 28 percent of the population.

So if 2015 ends up another dry year, Southern California could be forced to have mandatory water rationing by 2016.

But six weeks later, Moody’s has put out another release that examines how much strain the law meant to stabilize funding for California teachers’ pensions is likely to put on the state budget and warns about the effect on some school districts:

The rate increases that CalSTRS is instituting are modest and manageable for school districts over the  next three years. For 2015, school district contributions will increase by only 0.63% of payroll to total 8.88%, which is below the 9.5% that the governor included in the May revised budget. Fiscal 2015 school district budgets would likely have included the higher 9.5%, so the lower adopted rate is budget positive.

Over the next three years, school districts will receive higher LCFF funding from the state which will more than compensate school districts for their higher pension expenses. School districts’ pension contributions will amount to only 25% of the projected increase in LCFF funding over the next three years. Employers, consisting mostly of school districts, will contribute $1.29 billion more toward the CalSTRS pension plan, but LCFF funding will increase by $5.26 billion through fiscal 2017. …

Managing rising pension costs will prove challenging over time because CalSTRS rate increases are back-loaded. School districts face future budgetary stress not only from rising pension costs but from salary and benefit expenditures and programmatic priorities. Further, school districts have minimal revenue flexibility. … Rising pension costs will pressure financial operations and may cause a deterioration in credit quality for some school districts.

An ‘inflection point’ for the bond market?

To get a handle on the implications of this, I turned to someone who speaks bond. Dan McSwain is a successful businessman turned journalist who is now an unusually insightful business columnist for the U-T San Diego. (Enjoy his amazing look at the latest Socal pension follies here.) Dan thinks that Moody’s is sending a clear warning signal to investors — and to the state of California.

… ratings agencies telegraph future adjustments far in advance, when they can. And this is definitely a shot across the bow of the school bond issuers themselves. So while CalSTRS might keep its rating, I wouldn’t be surprised to see a series of downgrades in a few years for districts that issued all those stupid long-term iPad bonds over the last few years. They’ve gotten a decent bump in cash flow this year and last, but this retirement contribution squeeze could get tight very fast when the next recession comes and the state pulls back again.

Also, downgrades can cause a vicious cycle, triggering selling by mutual funds and pension funds that are required to keep only top-rated munis in their portfolios. This doesn’t hurt issuers directly; only bond holders who want to sell before their bonds reach full term. Yet when the buy side disappears, it kills the ability of schools and governments to sell new bonds. These guys depend on the ability to sell new bonds whenever they want to refi or build something, because they don’t build construction reserves in California.

Maybe I’m looking too far down the road, but this Moody’s advisory seems like an inflection point of some kind.

I defer to Dan on how to interpret Moody’s actions. But I think the Cal Watchdog piece I wrote in May about the dog-eat-dog budget politics that are sure to result from the CalSTRS fix looks more likely to come true than ever. The state of California can’t just casually come up with $4.5 billion a year — because it can’t print money.

Covering the cost of the CalSTRS bailout going forward is going to be the Sacramento version of the federal budget sequester for non-education budget categories. Spending on just about everything but  K-12 is going to be curtailed.

By Chriss Street

Last week, we first reported first that “Permanent Link to Calif. sales tax revenue nosedives 33.5%,” then that “Moody’s warns of mass Calif. municipal bankruptcies.”

During the Great Recession of the last four years, the California private sector was forced to slash employment and infrastructure spending, but the public sector made only modest cutbacks. Much of this state and local spending was funded by selling municipal bonds to elderly investors who were told the “muni market” was safe because the default rate is very low.

Now a new Federal Reserve Board study, “The Untold Story of Municipal Bond Defaults,” debunks the belief that municipal bonds are safe investments and blames the Moody’s and S&P credit rating agencies for deceiving the public. This is sure to fan the flames of the growing panic among holders of California municipal debt. According to the August 15 report:

“The $3.7 trillion U.S. municipal bond market is perhaps best known for its federal tax exemption on individuals and its low default rate relative to other fixed-income securities. These two features have resulted in household investors dominating the ranks of municipal bond holders.”

Individuals own three quarters of all municipal bonds; with $1.879 billion held directly and another $930 billion through investments in mutual funds.  The Fed report emphasized that the perception of a low historical default history of municipal bonds has played a key role in “luring investors” to buy huge amount of municipal debt.

The Fed specifically points out that the perception of low default rates is due to widely advertised reports of low default rates by credit-rating agencies.  But the Fed determined the credit-rating agencies have not told the whole story about the level of municipal bond defaults.

Default records

Moody’s Investors Service and Standard and Poor’s (S&P), the two largest bond rating agencies, provide annual default statistics for the municipal bonds.  S&P reported that its “rated” municipal bonds defaulted only 47 times from 1986 to 2011.  Similarly, Moody’s indicated that its “rated” municipal bonds defaulted only 71 times from 1970 to 2011.  This compares much more favorably to the record of thousands corporate bond defaults during the same period:

But when the Fed tracked default listings from 1970 to 2011 through the Mergent and S&P Capital IQ data bases available to institutional investors, the municipal default rates during the same periods skyrocketed from 71 to 2,521 for Moody’s and 47 to 2,366 for S&P.  The Fed calculated that there were a total of 2,527 municipal bonds that defaulted from the late 1950s through 2011 — confirming that the real rate of municipal bond defaults was 36 times higher than Moody’s and S&P reported to the public.

The Fed warned that information regarding municipal bonds tends to be “self-selected.”  Issuers stop seeking an annual rating from Moody’s and/or S&P, if their bonds are likely to not receive an “investment grade” rating.

The Fed also determined that “the municipal market is bifurcated into general obligation (GO) bonds and revenue bonds.”  GO bonds carry a full faith and credit pledge of a state or local government, but revenue bonds are backed by a pledge of revenues raised from a specific enterprise, such as an airport, hospital, or school.  According to the Fed, over the past 16 years, 60 percent to 70 percent of newly issued municipal bonds were revenue bonds.  Many of these projects appear to be politically justified to bankroll crony capitalist “sustainable” investments as industrial development bonds.  IDB financings often involved new technologies or projects with no historical track record. The Fed wrote:

“the services offered by an alternative energy plant, pollution control facility, or other corporate-like entity may not be considered essential, because of the availability of other energy sources. Thus, these enterprises may have less potential to generate revenue.”

Culpable

The bottom line of the Fed report is Moody’s and S&P are culpable for understating the risks to investing in the municipal bond market.  Within 48 hours of the release of the Fed report, Moody’s acknowledged 10 percent of California cities have declared fiscal crises and disclosed that “across-the-board rating revisions are possible following a review of our ratings on California cities over the next month or two.” Based on the Fed report and Moody’s reaction, California and other municipal bondholders should be panicked.

Chriss Street and Paul Preston Co-Host
“The American Exceptionalism Radio Talk Show”
Streaming Live Monday Through Friday at 7-10 PM
Click Here to Listen:  http://www.mysytv.net/kmyclive.html

By Chriss Street

The klaxon horn went off Friday evening for California municipal bondholders when Moody’s Investors Services issued a report stating that the plummeting financial condition of many California counties, cities, school districts and other government agencies will soon result in a large numbers of municipal bankruptcy filings.  Concerned about their own potential liability for providing high ratings that encouraged conservative elderly Americans to invest in risky bonds, Moody’s announced they will undertake a wide-ranging review of municipal finances because of the growing insolvencies.

The Moody’s report comes just two days after we reported, “California sales tax revenue nosedives 33.5%.”  Stock brokers have often recommended California municipal bonds as very safe investments, due to historically low default rates and relatively stable finances.  But Moody’s said that outlook is changing after the Chapter 9 Bankruptcy filings of Stockton, San Bernardino and Mammoth Lakes.

Moody’s is especially concerned with the growing attitude among many cash-strapped cities that filing bankruptcy to avoid paying bondholders is politically more advantageous than cutting spending.  As a result, Moody’s will reassess the financial condition of all California cities, which issue about 20 percent of the municipal bond volume nationwide, “to reflect the new fiscal realities and the governmental practices.”

Other states

The Moody’s report said the credit rating service will also examine the outlook for municipal bonds in other troubled states.  Robert Kurtter, managing director of public finance at Moody’s, would not say which states they will review, though Kurtter mentioned Michigan and Nevada as possibilities.

Tonight’s report noted that many cities across the nation are in financial distress, but emphasized that a greater share of bankruptcies are expected to come from California.  Local officials were quick to try to downplay this grim forecast.  Chris McKenzie, executive director of the League of California Cities, responded: “Moody’s has an obligation to review changing circumstances, but we would just suggest that their assessment of the framework and ground activities is perhaps exaggerated.”

Tom Dressler, spokesman for California State Treasurer Bill Lockyer, cautioned against overacting to only three bankruptcies from California’s 482 cities: “No city’s going to blithely skip into bankruptcy court to avoid its obligations.” He called the report “a little hyperbolic.”

California cities in crisis

Moody’s detailed that more than 10 percent of California cities have already declared fiscal crises, with the most troubled areas lying inland in the middle of the state and east of the Los Angeles area.  Mr. Kurtter said the declarations of emergency were “a reflection of the broader fiscal stress in the state” and went on to warn that Moody’s may find that, for all California cities, “across-the-board rating revisions are possible following a review of our ratings on California cities over the next month or two.” Chris McKenzie acknowledged that such a move “would have a terrible impact on taxpayers.”

Moody’s highlighted growing doubts that cash-strapped cities are willing making good-faith efforts to pay their bond debts in full.  Former U.S. Treasury official Paul Rosenstiel, a principal at the DeLaRosa & Co municipal bond investment-banking firm in San Francisco said, “Credit analysis is based on the ability to pay and the willingness to pay.  Investors have historically assumed that cities are willing to pay their debts because they want continued access to the bond market.… What is being considered is whether the willingness to pay is something that needs to be factored in more than in the past — and if so, how would you measure it?”

California cities already pay higher interest rates to borrow money from municipal bond investors because the state has the second lowest bond rating in the nation; only Louisiana is lower.  But if any city’s credit rating is cut to the “junk bond” level, rates would rise so high that the city would be forced to file bankruptcy.  Most cities already are financially deteriorating because of a steep drop in tax revenue.

The Moody’s report is raising alarms for city leaders who fear it may trigger a market panic.  “Every city in the state is looking on with some concern,” said Dave Vossbrink, spokesman for the city of San Jose.  “Governments of all kinds borrow money, usually to build infrastructure that lasts a long time.  It’s like getting a mortgage to build roads, a sewage plant, whatever it might be.”  Mr. Vossbrink emphasized that San Jose has cut laid off cops and closed libraries.  Residents also recently voted to cut public pension benefits for city workers, but those cuts may not be enough prevent a downgrade.

Moody’s said it will conduct in-depth financial stress tests for all California cities in the coming weeks and issue appropriate downgrades in September.  The timing of the Moody’s downgrades may be especially devastating for the California state budget.  Gov. Jerry Brown kicked off his drive this week to save the state’s solvency by encouraging voters to pass an $8 billion tax increase initiative on the November ballot.  But bad press and rising bankruptcies are sure to undermine voter support.

Chriss Street and Paul Preston Co-Host
“The American Exceptionalism Radio Talk Show”
Streaming Live Monday Through Friday at 7-10 PM
Click Here to Listen:  http://www.mysytv.net/kmyclive.html

By Chriss Street

The state of California was already facing a $19 billion budget deficit, had shorted K-12 public schools $8 billion and are releasing imprisoned rapists into the “community probation” when the California Legislature’s Democratic majority voted last week to approve selling $4.6 billion in new state bonds to build 130 miles of railroad track through some of the most uninhabited farm country in Central California.

The arrogance of the leveraging the already insolvent state caused a volcanic public outrage. But the Legislature and Governor Jerry Brown were desperate to get their paws on $3.3 billion in federal grants from the Obama Administration.

Then, in a shocking development, Moody’s Investor Services, which was expected to provide the credit rating to justify selling the debt, may have just torpedoed California’s credit rating by tripling their estimate of the state’s unfunded public pension liability from $38.5 billion to a $109.1 billion liability and raising the annual cost of state pension funding by $7.3 billion.

California has long been ground zero for financially dysfunctional government.  Under the California State Constitution, the Legislature is required to approve a “balanced budget” each year.  At the start of the fiscal 2011-12 budget on July 1, 2011, California had an $8.2 billion budget deficit carry-over from the prior year.  No problem for Sacramento political magicians to balance a budget. They simply estimated the state would collect $9.7 billion in capital gains taxes from the Facebook initial public offering.

Twelve months later, the state has collected less than $1 billion from Facebook and the deficit has grown by another $1.4 billion to $9.6 billion.  This year, the Legislature passed another dicey “balanced budget” on the expectations voters would approve in November $8.5 billion in new sales and income taxes.

Ponzi spending

The key to California politicians being able to continue their Ponzi spending far above the state’s revenues has been the willingness of ratings agencies, like Moody’s, to dutifully collect huge consulting fees for providing the state with an “investment grade” credit rating.  Armed with the Moody’s “Good Housekeeping Seal of Approval,” municipal bond investors have been willing to loan California huge amounts of cash.

But the bogus choo choo bonds may have been so toxic even for Moody’s high tolerance for government shenanigans; they were the proverbial “straw that broke the camel’s back.” If Moody’s issued an investment-grade credit rating and the railroad bonds eventually default, the firm would undoubtedly be sued for billions of dollars by lots of angry retired people who tend to be the main buyers of municipal bonds.

This newfound conservatism by Moody’s comes at a very inopportune time for the state and its 58 counties and 478 cities.  Each year, California governments have borrowed huge amounts of money by selling low-cost municipal bonds in late July to finance the period until they collect the majority of their tax revenues in December and April.  The state of California was expecting to borrow $28 billion and municipal governments were anticipating borrowing anther $50 billion.

But any downgrades of the state or municipality debt from investment grade to “junk bond” would send the cost of borrowing up to Greek-like levels of 20 percent.  This appears to be exactly what just happened to San Bernardino, forcing the city to file for an emergency Chapter 9 municipal bankruptcy.  According to Los Angeles Times:

“The city’s fiscal crisis has been years in the making, compounded by the nation’s crushing recession and exacerbated by escalating pension costs, lucrative labor agreements, Sacramento’s raid on redevelopment funds and a city reserve that is tapped out”.

This same language could apply to most of the cities and counties in California over the last few years.  The real reason for the collapse of San Bernardino and the growing panic is Moody’s was about to downgrade the city’s credit rating to junk.  With state and most local governments running out of cash, there will be more bankruptcies in California.  It looks to me that it was the train that broke California’s back.

Chriss Street will be in Studio with Paul Preston on “The Inside Education”; Streaming Live from Monday July 9 to Friday July 13.  Click Below to listen between 7-10 pm each night:  www.mysytv.net/kmyclive.html.

They were slapping high fives in the offices of state Treasurer Bill Lockyer this week. Why the celebration?  Because California no longer has the nation’s worst credit rating, according to Moody’s Investors Service.

“The reason we’ve improved our standing,” said Tom Dresslar, spokesman for the treasurer’s office, “is because of the actions that the Legislature and the governor have taken last year, with regard to the budget.”

To wit, he elaborated, “They took some major steps to solving our structural deficit, and we started to pay down what the governor calls ‘the wall of debt.’ And those steps have not gone unnoticed by the rating agencies and they have given us credit for those actions.”

Well, not exactly Tom.

First of all, California really did not “improve” its standing. It simply moved from worst to next to worst because Moody’s downgraded Illinois (which, it should be noted, has a Democrat governor and Democrat-controlled state Legislature, just like California).

Also, neither Moody’s nor the other two major credit-rating agencies — Standard & Poor’s and Fitch Group –have really “given (California) credit” for the actions Gov. Jerry Brown and the Legislature took last year on the state budget. In fact, S&P and Fitch continue to rank California’s creditworthiness 50th among the states.

‘Missed Opportunity’

S&P said last summer that the budget the party of Brown enacted amounted to “a missed opportunity” because it failed to address the “backlog of budget obligation accumulated during the past decade.”

Fitch declared California’s fiscal and credit prospects “clouded,” not the least because of “extensive budgetary pressures confronting the state’s constrained financial flexibility stemming from voter initiatives.”

What particularly resonated was Fitch’s admonition that California’s credit rating should not be so low “considering the size and breadth of the state’s economy and tax base” as well as “the strength inherent in a state’s sovereign powers.”

Indeed, California continues to boast one of the world’s 10 largest economies. The state government collects $90 billion or so in annual revenues. If the budget-making process in Sacramento hadn’t long been so dysfunctional, the state would not now be struggling with its structural deficit. It would not have the nation’s worst credit rating.

Dresslar estimated that the state’s structural deficit is $9.2 billion. He also maintained that Gov. Brown’s proposed 2012-2013 budget will eliminate that structural deficit and, in turn, move the Golden State up a tier or more in the credit ratings.

Trickeration

But the governor’s budget relies on the same kind of fiscal trickeration that produced the backlog of budget obligations to which S&P referred. Most noteworthy, he includes $6.9 billion worth of tax hikes in his budget that require the unlikely approval of California voters.

Without those tax hikes, the governor’s budget falls apart, as a new report this week by the state Legislative Analyst’s office attests. And once that happens, we’ll see the same excruciating fight in Sacramento over taxes and spending that we’ve witnessed for far too many years.

Some say that California’s perennial budget problems are unsolvable. But that is not so. All lawmakers need do is study the best practices of the states that the credit rating agencies rank in their top ten.

Aside from their enviable creditworthiness, those states have four things in common:

They control their spending, not letting yearly outlays outpace inflation and population growth. They do not create (or expand) state programs anticipating new revenues that may not materialize.

They prepare for lean economic times by setting aside windfall tax revenues during economic boom times. And they keep their tax burdens among the lowest in the country, recognizing that lower taxes lead to greater economic growth and more overall tax revenue flowing into state coffers.

– Joseph Perkins

By CHRISS STREET

The California state government’s general fund is running a staggering cash deficit of $21 billion on an $88.5 billion budget. The number comes from Controller John Chaing just-released financial statement for December 2011. The bad news came in the face of strong national consumer spending and private-sector employment gains

This imploding financial condition is a reflection of how California’s high business taxes and excessive regulations are accelerating the trend of businesses abandoning the state.  According to Chaing, “While we saw positive numbers in November, December’s totals failed to meet even the latest revenue projections.  Coupled with higher spending tied to unrealized cost savings, these latest revenue figures create growing concern that legislative action may be needed in the near future to ensure that the State can meet its payment obligations.”

The above are “code words” that the state is in financially dysfunctional and it’s getting worse.  Compared to the previous year, California revenue of $39.4 billion for is down by 11.2 percent for the fiscal year to date (July – Dec. 2011). That’s due mostly to a 26.4 percent nose dive in sales tax collection. And state spending of $52.3 billion is currently running 33 percent higher than the state’s revenue.

Tax Increases

The controller does not seem impressed that Gov. Jerry Brown and the Legislature’s only solution to fix this budget mess is to relying on voter willingness to approve an initiative to raise the already hefty sales tax they pay by 13 percent and add another surtax on the wealthy to generate $6.9 billion in revenue.

Even if the public shocks pollsters and actually passes the tax increase, the non-partisan Legislative Analyst’s Office calculated the initiative would only generate $4.8 billion per year.  Prior to the Controller’s grim report of a $5.2 billion budget miss, the LAO had already estimated that state’s revenue would be $3.7 billion below forecast and “trigger” $2 billion of automatic budget cuts to K-14 education.  The LAO’s estimate of a $13 billion deficit next year, due mostly to constitutionally required “settle up” payments for short-checking public schools in prior years, now looks like a $20 billion deficit.

California’s budget projections are so consistently whacky that the Governor closed the California Recovery website this summer to avoid ridicule regarding its ludicrously optimistic recovery projections.  Despite creating one of the most unfriendly business climates in the nation, for 20 years California’s socialist politicians were able to do the “la vida loca” spending on the back of an epic real estate boom.  With the real estate bust now in its fourth year, California ranks third in the nation in foreclosures. And according to the Foreclosure Radar Report, it is one of only two states in the nation where foreclosures increased in December.

Credit Ratings

The credit rating agencies will undoubtedly take a very hard look at downgrading California’s municipal bond debt, which is already the worst rated in the nation at only two notches above junk.  But the budget disaster also spells bad news for the credit ratings of California local governments.  Last year the Legislature passed a law striping $1.7 billion per year from state’s 400 redevelopment agencies to augment its own budget shortfall.  Moody’s Investor Services immediately put $11.6 billion of California tax allocation bonds on review for a possible downgrade.  Moody’s stated, “If left unchanged, this law would be significantly negative for bondholder credit.  This legislation could result in multi-notch downgrades on bonds of the dissolved redevelopment agencies.”

Perhaps California’s budget problems can be best understood from a Fox Television interview of Joseph Vranich, president of the Business Relocation Coach. He makes his living moving companies out of California. (See video below.) He said businesses leave to avoid “high businesses taxes and excessive regulations imposed on commercial enterprises of all types.  Costs are illustrated by the fact that a business leaving the city of Los Angeles for a nearby county can save up to 20 percent in costs while moving to another state can save up to 40 percent in costs.”

Vranich pointed out that, in the first half of 2011, there were 129 companies with 100 or more employees that moved out of the state.  This averages 5.4 larger companies leaving for “greener pastures” per week, versus 3.9 per week in 2010 and only 1 per week in 2009.  The top relocation destination is not China, but  the neighboring business-friendly states of Texas, Arizona, Colorado, Nevada and Utah.

Other People’s Money

British Prime Minister Margaret Thatcher, in a TV interview in 1976, famously said, “Socialist governments traditionally do make a financial mess.  They always run out of other people’s money.  It’s quite a characteristic of them.”  If she were to move to California 35 years later, she would add, “Or else the other people will take their money and just leave!”

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Joseph Vranich video:

Why Businesses Move Out of California: MyFoxLA.com