Senate leaders unveil a budget agreement after bonds are downgraded to
their lowest level ever.
By Evan Halper, Jeffrey L. Rabin and Nancy Vogel
Times Staff Writers
July 25, 2003
SACRAMENTO — California's credit standing was lowered three grades
Thursday, and two hours later Senate leaders announced that a state budget
agreement had been reached and would be passed by their members on Sunday.
If the leaders can deliver the votes of other lawmakers as expected, the
deal would signal the end of a months-long stalemate over how to resolve a
$38-billion shortfall that has threatened to cut off services to millions
The credit downgrade had an immediate political impact in the Capitol,
where lawmakers worried about being blamed for the state's financial slide.
For the last several months, officials of Davis the administration have
been using the fear of Wall Street as a goad to push reluctant legislators
toward a deal.
Legislative leaders spent Thursday morning denying that an agreement was
close. But soon after the rating news, Senate President Pro Tem John Burton
(D-San Francisco) and Republican leader Jim Brulte of Rancho Cucamonga confirmed
the deal. They insisted that the downgrade did not compel their announcement.
The change in credit status "is unprecedented bad news that will send
shock waves throughout the nation," said Controller Steve Westly. "It is
a very sad day for California. This damages California's financial reputation
and can take years to dig out from."
Bond analysts were more temperate, however.
"It is a bit of an alarm," said Lauren Post, head of municipal bond research
at Stone & Youngberg in San Francisco, one of the state's largest bond
"We are going to urge our investors not to panic," Post said. "These bonds
are backed by the full faith and credit of the state, which has an obligation
to tax as needed to pay off these securities."
In a move that will cost investors and state taxpayers hundreds of millions
of dollars in additional interest and fees, Standard & Poor's dropped
its measure of California securities from an A rating — already the lowest
of any state in the nation — to BBB, the last point at which offerings are
considered "investment grade." California's state-backed obligations have
never been so poorly regarded.
Standard & Poor's officials made clear that any move to effectively
paper over the shortfall by borrowing huge sums — as the Senate compromise
proposes — would leave a structural imbalance between what the state spends
and what it collects in revenue.
The rating downgrade was a resounding vote of no confidence in the Legislature
and Gov. Gray Davis over their failure to resolve a fiscal crisis that has
steadily worsened during the last three years. Under the spending plan worked
out in the Senate, officials said, a $7.9-billion shortfall would emerge next
"Just bonding your present deficit and not doing anything to close the
hole where you are leaking red ink is not progress," said Steven Zimmermann,
managing director of S&P's western region. "We want to see movement toward
closing the structural imbalance."
Burton said the rating action did not force the budget deal.
"I don't care about Standard & Poor's, and I don't care about Wall
Street," Burton said. "I care about 27 and 54 and a signature."
He was referring to the supermajority of votes necessary for the Senate
and Assembly to pass the bill and send it to Davis for signing. The Senate
budget proposal calls for obtaining billions of dollars in loans, primarily
$10.7 billion in borrowing to roll over part of the deficit into the next
Burton said he is unconcerned about getting those loans or repaying them.
"The money will be there to pay off the bond," he said. "It is that simple."
State Finance Director Steve Peace said that although the money may be
there, borrowing it could cost California hundreds of millions of dollars
The credit downgrade, he said, will have the immediate impact of adding
$34 million to the cost of an $11-billion bridge loan the state has outstanding.
That borrowing, completed last month, was necessary to pay off earlier
loans and provide enough cash to keep the state afloat through August because
the budget debate extended into the new fiscal year.
Any further drop in the credit rating would result in additional payments
to a syndicate of banks that guaranteed the state's borrowing.
S&P's action also could drive up costs for other bonds that the state
is preparing to sell.
"There's no reason for [institutional investors] to go to California when
they can put the money elsewhere with less risk," Peace said. "So they'll
demand as a condition of continuing to invest in California a higher interest
rate, a higher price."
Peace said that also will result in cities and counties having to pay
more to borrow.
"There's a psychology in the market that influences the whole package
of California paper," or debt, he said.
The BBB level is "an extremely low rating for a state," said S&P's
Since the peak of the stock market in 2000, California's credit rating
has dropped sharply as income tax revenue from capital gains on stocks and
stock options went into a free fall.
"It is going to be very difficult for us to borrow more money at all,"
Westly said. "Very few people are going to have an appetite for California
The drop to BBB is not unprecedented. Louisiana and Massachusetts also
have been at that level, although they are higher now.
Securities traders said they didn't want to speculate on how much yields
on California's general obligation bonds would rise as a result of the downgrade
— something they will find out today when the bond market opens for trading.
California was already paying more interest than higher-rated states.
The budget deal to be voted on Sunday in the Senate includes no additional
cuts to kindergarten through 12th-grade schools, but makes significant reductions
in some health-care programs and a $1.2-billion cut in aid to local governments,
The proposal also includes a tax swap between state and local governments
that would provide $2.3 billion annually to pay for the deficit loans.
The state would take a half cent of sales tax revenue from cities and
counties, and local governments would be reimbursed with an equal amount
of new property tax revenue that has been going to the state.
Democrats had long resisted the swap, pushing instead for a sales tax
increase that would create a new revenue stream to finance the deficit. But
Republicans refused to approve any new taxes. The swap compromise would result
in a net loss for the state, and that forced Democrats to accept more cuts.
Yet Burton said that despite more trims in Medi-Cal and other programs,
Democrats were able to limit the pain to the poor. He said his GOP counterpart,
Brulte is "happy with the 'no tax' thing and I'm happy with the protection
of the aged, blind and disabled."
As for the $7.9-billion budget hole that would occur next year under the
plan, Brulte said it is a major improvement over where the state is now.
"No matter how much I would like to, I do not know how to eliminate that
deficit that took three years to create in one year," he said.
"And if at the end of the day, we come back here next May or June with
a $7-billion or $8-billion problem, instead of a $38-billion problem, I consider
that a huge step forward.... I'm absolutely convinced the [financial] markets
will consider it a huge step forward."
Davis praised Brulte and Burton for striking a deal and called the rating
action "our latest and loudest wake-up call," adding that "it's imperative
that the Legislature pass a budget and pass it quickly."
A spokesperson for the governor noted that the agreement reflects much
of what was in the budget Davis proposed in May.
Times staff writers Carl Ingram and Debora Vrana contributed to this