Tags: Budget | Kabuki | California | Debt | Costs

'Budget Kabuki' Increases California’s Debt Costs

Thursday, 02 September 2010 09:05 AM

California’s borrowing costs are rising, even as Governor Arnold Schwarzenegger says he’s not ready to call lawmakers into special session to eliminate a $19.1 billion deficit before the state runs out of cash.

The extra yield investors demand on 10-year California bonds rose to 124 basis points above AAA rated municipal securities yesterday, up 14 percent in a week, Bloomberg Fair Value Index data show. The increase comes as the state will need to borrow as much as $10 billion in short-term notes within four weeks of any budget agreement and more than $6 billion in longer-dated bonds by December for public-works projects.

California hasn’t had a budget since the fiscal year began on July 1. Schwarzenegger, a Republican, yesterday said he would resume private negotiations with Legislative leaders after lawmakers rejected a pair of dueling deficit-cutting plans and then adjourned for the year. The state may need to issue IOUs to pay bills by next month and Standard & Poor’s has said it may cut California’s A- rating, already the lowest among states.

The “budget Kabuki did not bring us any closer to a solution, but it did highlight the fundamental and critical differences about how to close our deficit and bring our economy back,” Schwarzenegger told reporters in Sacramento.

California last sold general-fund backed bonds in June, when it offered about $120 million of debt for veteran’s homes. The state sold $450 million of public works bonds in May and $5.9 billion of debt in March.

The state’s credit grade may be cut if the stalemate continues for several months or more, S&P said in June. A lower rating may add to California’s borrowing costs.

The stalemate also has forced up the price of credit- default swap contracts on California bonds. A contract maturing in 10 years rose to about $300,000 to protect $10 million of bonds on Aug. 31, the highest since July 12, according to data compiled by Bloomberg. The cost slipped to $295,000 yesterday.

“We’re waiting it out,” said Kenneth Naehu, a managing director at Bel Air Investment Advisors in Los Angeles. He manages almost $3 billion in municipal bonds.

“We don’t have to chase yield,” Naehu said in a telephone interview. “California general-obligations, if they get downgraded, could go 150 basis points over high grades versus 124 now.” A basis point is 0.01 percentage point.

Yields on top-rated tax-exempt municipal debt due in 10 years rose 3 basis points Wednesday to 2.61 percent, the second rise in yields since June 15, according to data from Concord, Massachusetts-based Municipal Market Advisors. The first increase since June, also of 3 basis points, was on Aug. 27.

Municipal interest rates were driven to record lows last month as investors sought the perceived safety of the market amid concern that the economic recovery may be slower than expected. Yields fell about 10 percent in August, to 258 basis points on Aug. 25 from 286 basis points on July 30. A yield of 2.58 percent is the lowest ever, according to MMA data dating to January 2001.

“My thought is that it may be more directly related to the general market movement and that it’s not a direct consequence of the budget impasse,” state Treasurer Bill Lockyer said in a telephone interview.

California requires a two-thirds vote in both legislative chambers to pass budgets, and neither Republicans nor Democrats hold enough seats to meet that threshold. Schwarzenegger and Republicans want to dismantle the state’s main welfare program and slash $12.4 billion of spending. Democrats proposed $5.9 billion in higher taxes and fees combined with spending cuts.

California’s constitution says lawmakers must send a budget to the governor by June 15, a deadline they’ve met five times in the last 30 years. The 2008 budget was enacted 85 days into the fiscal year, the latest ever. The second latest was signed into law Sept. 5, 2003.

Absent a budget, the state can’t sell the short-term notes it typically uses each year to bridge cash shortages, because repayment of the debt must be part of an approved spending plan. Chiang and Schwarzenegger’s department of finance have said the state may need to borrow as much as $10 billion on a short-term basis once a budget is signed. The state sold $8.8 billion of such notes in September and repaid the loan June 23.

“It’s harder to finish the fiscal year with a sizable cash-flow surplus,” Lockyer said. “And without a significant surplus at the end of the year, bond investors tend to be a little bit more anxious and the cost of borrowing increases.”

© Copyright 2010 Bloomberg News. All rights reserved.


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California s borrowing costs are rising, even as Governor Arnold Schwarzenegger says he s not ready to call lawmakers into special session to eliminate a $19.1 billion deficit before the state runs out of cash. The extra yield investors demand on 10-year California bonds...
Thursday, 02 September 2010 09:05 AM
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