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California's low credit rating: Investors win, taxpayers lose

February 3, 2009 |  7:56 pm

When the state of Georgia sold 10-year bonds on Monday, it paid an annualized tax-free interest yield of 2.99% to the investors who bought the IOUs.

If California tried to sell 10-year bonds now, it probably would have to pay about 4%.

That shows the steep penalty that taxpayers of the Golden State incur for its low credit rating, which sank even further on Tuesday: Standard & Poor’s downgraded the state’s $46 billion in general obligation bond debt to an "A" grade from "A-plus," giving California the dubious distinction of being the lowest-rated of all 50 states.

But debt ratings are relative. Being at the bottom with an "A" grade doesn’t mean that S&P believes California is in danger of reneging on its debts. In fact, the state Constitution mandates that the state must repay its bondholders.

Calstatehousedome What the rating amounts to is a rebuke to California for its failure to get its fiscal act together, as Gov. Arnold Schwarzenegger and the Legislature continue to battle over how to close gaping 2009 and 2010 budget holes totaling $42 billion.

But if there’s really no default risk, why should California be rated much differently than, say, Georgia, which has a grade of "AAA" from S&P? That’s an argument that state Treasurer Bill Lockyer has raised over the last year, seeking to force the rating firms to change their methodologies.

Given the magnitude of California’s financial problems, however, it’s hard to imagine that investors wouldn’t demand some kind of interest-rate premium on the state’s debt, regardless of the official ratings. We may not be a deadbeat, but we sure give off that vibe.

Yet even though California must pay more to borrow than many other states, this might actually be a good time for Lockyer to sell some of the huge backlog of general obligation bonds that voters have approved for infrastructure projects.

Why? Because many investors, fed up with the devastated stock market, are hungry now for income-generating securities that offer relative safety of principal.

"There’s extraordinary demand from individual investors for muni bonds," said Matt Fabian, a managing director at Municipal Market Advisors in Westport, Conn.  . . .

Unhappy with low rates on U.S. Treasury securities and bank savings certificates, "Investors are trying to come into the muni market and pick up a little extra yield," said Paul Brennan, a bond fund manager at Nuveen Asset Management in Chicago.

The net effect of that buying has been to push tax-free muni yields overall lower since mid-December -- including yields on California bonds.

One looming test of investors’ appetite for munis: The Los Angeles Unified School District on Wednesday will offer $950 million in bonds for sale, to fund building projects.

On Tuesday, the district allowed individual investors to place orders for the bonds (rated "AA-minus" by S&P), ahead of institutional investors. Total orders from individuals came to $254 million, said Tim Rosnick, a finance officer for the district.

"This is as well as we’ve ever done" for sales to individuals, he said.

So the appetite is there for muni bonds, despite the state’s economic nightmare. Maybe that’s a vote of confidence in California -- or just plain desperate greed.

Either way, with investor demand strong, Lockyer spokesman Tom Dresslar said Tuesday that "we’re exploring the potential for getting back into the market" with bond sales.

As the largest state in the Union, it’s never a question of whether California can borrow; it’s just a question of the price imposed on current and future taxpayers.

-- Tom Petruno

Photo: The Capitol in Sacramento. Credit: Ricardo DeAratanha/Los Angeles Times

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