|California Creditors Dread IOUs With Aid Plea Failing (Update1)|
By Edwin Chen, John McCormick and Michael Marois
Jan. 13 (Bloomberg) -- California’s hopes are fading for federal help in closing a projected $19.9 billion deficit that has caused the lowest-rated state’s borrowing costs to rise 24 percent in three months.
“We recognize they have enormous problems,” David Axelrod, senior adviser to President Barack Obama, said in an interview. “But we can’t solve all of those problems from Washington.”
Investors are growing more concerned that California, the world’s eighth-largest economy, will repeat last year’s fiscal crisis that forced it to use IOUs to pay bills. With Governor Arnold Schwarzenegger seeking $6.9 billion in federal assistance to narrow the deficit, the extra yield paid on the state’s 10- year bonds over AAA-rated municipal securities rose to 1.31 percentage points yesterday from 1.06 points in three months, according to Bloomberg fair market value index data.
Schwarzenegger’s plea for help may become a test case for Obama, who last year called the 62-year-old Republican governor “an outstanding partner with our administration.” Dozens of states face budget shortfalls amid the worst recession since the Great Depression, and at least 36 have already reduced fiscal 2010 expenditures, according to the National Association of State Budget Officers.
“There’s a huge amount of concern about California,” said Howard Cure, who helps handle municipal-bond investments for Evercore Wealth Management in New York, which oversees $1.5 billion. “There’s a relatively large reliance on hoping that the federal government will send extra money their way. It’s going to be very politically difficult for that to happen.”
Schwarzenegger wants the Democratic president to reduce required programs, waive rules and provide additional funding. In recent days, the governor has stepped up his campaign for “fairness,” focusing much of his Jan. 6 state of the state address and Jan. 8 budget address on an appeal for a greater share of federal money.
“It is unfair the way the money is being distributed right now,” he said on NBC’s “Meet the Press” on Jan. 10.
“The federal government is forcing us to spend money we don’t have,” Schwarzenegger said in the Jan. 8 speech outlining his $82.9 billion spending plan for the fiscal year beginning July 1, speaking of education requirements and costs associated with detaining undocumented immigrants.
California, whose economic output is greater than that of Russia, may be in the greatest need of any state. It recorded the nation’s third-highest rate of home foreclosures in November, behind Nevada and Florida.
November’s unemployment rate in California was 12.3 percent; the national average is 10 percent.
The Golden State’s general-obligation debt rating from Moody’s Investors Service is Baa1, the eighth-highest investment grade, and A from Standard & Poor’s, the sixth-highest. Greece, the poorest rated member of the 16-nation Euro region, is ranked two steps higher at A2 by Moody’s and two lower at BBB+ by S&P.
An S&P/Investortools index of California state and local debt returned 13.2 percent in 2009, 1.4 percentage points less than the national average.
Mounting deficits are forcing California taxpayers to pay higher interest. The state’s 10-year bonds yielded 4.6 percent on Jan. 11, up from 4 percent on Sept. 30, according to Bloomberg indexes.
Average 10-year municipal tax-exempt security yields were 81 percent of those on U.S. Treasuries of comparable maturity on Jan. 11, according to a Municipal Market Advisors index. California’s obligations yielded about 0.9 percentage points more than the federal debt.
Schwarzenegger’s budget “relies on a substantial amount of federal funding that is unlikely to come,” said David Blair, municipal bond analyst at Pacific Investment Management Co. in Newport Beach, California, which oversees $24 billion in local- government debt. “This budget isn’t anywhere near providing a solution.”
California has recently received federal assistance. Its current budget, approved in July, includes about $8 billion in federal stimulus money.
The state also has benefited from Build America Bonds, a form of debt that was part of the economic-stimulus package passed by Congress almost a year ago that give issuers a 35 percent interest-rate subsidy. Local and state governments in California sold $15.5 billion of the debt since April, almost a quarter of the nationwide total, Bloomberg data show.
Less School Aid
Still, lawmakers in California, which accounts for 13 percent of U.S. gross domestic product, have slashed $32 billion in spending, cutting funding for schools, universities and welfare programs. They also have raised taxes by $12.5 billion during the past year.
In his state of the state address, Schwarzenegger called health-care legislation pending in Congress, Obama’s top domestic priority, a looming threat.
“While I enthusiastically support health-care reform, it is not reform to push more costs onto states that are already struggling,” he said.
Speaking of special Medicaid payments Senator Ben Nelson obtained for his state as a condition for supporting health-care legislation, Schwarzenegger said Nebraska “got the corn and we got the husk.”
‘Disaster for California’
Schwarzenegger urged his state’s congressional delegation to vote against the final bill because it is “a disaster for California” and “a trough of bribes, deals and loopholes.”
“In Hollywood, they use very vivid language,” Axelrod said of the speech. “He’s advocating for his state and that is much of what is motivating that.”
Obama and his party are unlikely to spark a voter backlash in California if the administration turns down the state’s appeal for financial dispensation, said Gary Jacobson, a political scientist at the University of California in San Diego.
California is “a pretty blue state, and his popularity remains high,” Jacobson said. “I don’t think the legislature or the governor can foist blame off on the Feds very effectively.”
Schwarzenegger, who leaves office a year from now because of term limits, declined an interview request. While Susan Kennedy, the governor’s chief of staff, said he has a “great” relationship with the president, she said she wasn’t aware of any off-camera time the two men have spent together. She said her boss calls Obama “visionary.”
Axelrod, 54, described the relationship between Obama and Schwarzenegger as “pretty good” while saying that uniform standards for federal aid must be applied to all states.
Schwarzenegger’s relationship is more complicated than what is typical between a governor and president of different parties.
California’s first lady, Maria Shriver, is the niece of the late Senator Edward M. Kennedy, a Massachusetts Democrat. Like her uncle, she endorsed Obama, 48, early in the presidential campaign.
Her husband, a former professional bodybuilder, made fun of Obama’s “skinny legs” and “scrawny little arms” as he campaigned with the Republican presidential candidate, Senator John McCain of Arizona.
Schwarzenegger and Obama started mending their relationship after the election. Since then, they’ve publicly praised each other.
Any disagreements they now have are over policy, Kennedy said. “He clearly separates the president himself -- whom he has tremendous admiration for and whom he likes personally and has a good relationship with -- from the policy,” she said.
While Kennedy said Obama has challenged Schwarzenegger to a basketball game, she said she doubts it will ever be played. “I’m not sure that Arnold can jump,” she said.
Schwarzenegger attended Obama’s inauguration in January 2009 and a meeting between governors and administration officials at the White House in February. He met again with the president in March to discuss infrastructure issues.
That same month, Schwarzenegger introduced Obama before a town-hall event in Los Angeles, calling him a “fantastic partner” for California. The president said the governor had “turned out to be just an outstanding partner with our administration.”
Schwarzenegger won early friendship from the new administration when he backed Obama’s $787 billion stimulus bill, joining three Republican governors to sign a letter of support. He also worked with the administration to establish the Governors’ Energy and Climate Coalition to back a comprehensive energy bill.
Such efforts may not be enough to persuade the president to provide much of the help Schwarzenegger seeks, Mac Taylor, California’s legislative analyst, said in a report yesterday. He estimated the state shouldn’t expect more than $3 billion if federal aid is approved.
“We believe that the likelihood of Washington agreeing to all of the governor’s requests is almost non-existent,” Taylor said.