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Moody's warns it may cut California's debt rating

January 21, 2009 |  4:06 pm

California, tied with Louisiana for the lowest credit rating among the states, now is in more danger of claiming rock-bottom all for itself.

Moody’s Investors Service today warned that it might downgrade California’s general obligation bond rating, currently A1, because of the state’s "significant budgetary shortfall, impending liquidity crisis, and lack of legislative solutions."

Louisiana also is rated A1. All other states are rated higher on Moody’s scale, typically AA or AAA.

Moody’s shift follows a similar warning on California’s debt rating by its rival, Standard & Poor’s, on Dec. 11. S&P also has California tied with Louisiana for last place on the ratings scale.

California_state_flag Moody’s indicated it’s running out of patience with the state as Gov. Arnold Schwarzenegger and the Legislature fail to agree on a plan to plug California’s massive projected budget shortfalls -- $15 billion in 2009 and $25 billion in 2010.

"Although the legislative and executive branch continue to debate fiscal and cash measures, and the legislature is required to come up with solutions by Feb. 3, we do not yet know whether solutions will actually be passed, or whether they will be workable, reasonable, and of a sufficient magnitude to achieve a degree of credit stabilization consistent with the current rating level," Moody’s said in a statement.

In theory, a low credit rating means a state should pay more to borrow than states with higher ratings. But because of its size and the large investor base for its tax-free bonds, California hasn’t always been penalized by the market despite its low credit standing. . . .

Even so, some money managers say they’ve been avoiding California’s $57 billion in outstanding general obligation bonds in part on the assumption that the state’s rating would fall further into the basement.

"We see a reasonable chance for a downgrade" given the budget mess, said George Strickland, manager of the Thornburg California Limited Term Municipal bond fund in Santa Fe, N.M. "We sold the last of our general obligation bonds last week."

As I noted in this earlier post on the muni market, the issue with California isn’t that the state won’t make good on its debts. It’s required to do so by the state Constitution.

But if the rating is cut, and investors demand higher yields on new bonds the state issues, older bonds issued at lower yields could fall in value, giving investors a paper loss.

-- Tom Petruno

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