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Wall Street Awaits Budget Without Panic

Bond raters realize that give-and-take process of crafting a spending plan takes time. At this early stage, economists see no need for doomsaying.

February 09, 2003|Evan Halper | Times Staff Writer

NEW YORK — They are two words often invoked ominously in Sacramento these days: Wall Street.

Lawmakers cite them during budget negotiations to warn of impending doom if one action or another is not taken. The implication is that a mysterious group of powerful New York financiers is growing frustrated with the state's budget bottleneck and is poised to bring California to its knees.

Example: "Wall Street is looking very closely at what steps are taken to address a $26-billion deficit, and without responsible action, California could find itself on the brink of bankruptcy," Assembly Republican Leader Dave Cox of Fair Oaks said Tuesday.

But talk to the folks who actually work on and around Wall Street, and the signs of panic simply aren't there.

Economists familiar with the workings of Wall Street -- not to mention the bond raters that lawmakers so fear -- said the hyperbole may be out of control.

Although California's budget gap is greater than that of any other state, things would have to get much worse in Sacramento, they said, before bond buyers lost their appetite for state-issued paper.

"Wall Street knows budgets aren't made in the first week in February," said Stephen Levy, director of the Center for Continuing Study of the California Economy in Palo Alto. "We're actually acting more reasonably as a state than we ever have before."

When Democrats charge that the state's credit rating will suffer if Gov. Gray Davis follows through on a threat to veto budget bills because they are tied to a hike in vehicle license fees, the complaints are overblown, Levy said.

So, he said, are Republican warnings that the Legislature's failure to provide the governor a package he was comfortable signing could damage the state's ability to borrow money.

"What the governor did was a step in a long period of negotiations," Levy said. "I don't know why anyone on Wall Street would be upset about that. All that happened is he didn't take the first deal offered."

The state's bond ratings have taken some hard hits since the governor reported in December that California's projected budget gap through fiscal 2003-2004 had ballooned to more than $34 billion. But most of the damage was done before lawmakers began casting dire warnings about provoking Wall Street.

Even with two out of three of the large bond rating agencies placing California in their bottom tier of states -- and the third, Moody's Investors Service, expected to follow next week by dropping the state to an A2 rating -- market analysts said there is still a large appetite for the state's bonds.

"We're the fifth-largest economy in the world," said Zane Mann, publisher of the California Municipal Bond Advisor. "No one seriously thinks the state of California is going to go broke. Those kind of comments are ridiculous."

Officials from bond rating agencies said that, considering how early it is in the process and how big the deficit is, the state is doing just fine in moving toward fixing its fiscal problems. Several said the inability of the state to approve any cuts or tax hikes in January was not alarming. In fact, they reported being heartened that at least some movement toward a solution had been made.

"It probably would have been more surprising to us if there had been some immediate budget agreement," said David Hitchcock, director of public finance ratings at Standard & Poor's.

In a typical year, California legislators do not begin dealing with the budget in earnest until about May. That, of course, is not an option this year, because the bond raters expect some savings by then.

But most remain confident that will happen.

"What analysts are looking for is evidence that steps are being taken to bring things back to stability, even if it doesn't all happen in one fiscal year," said Claire Cohen, vice chairwoman of Fitch Ratings.

Whether it is done with an increase in car-license fees, Medi-Cal cuts or new fees on timber harvesters is irrelevant, the analysts said, as long as the numbers add up and the state doesn't need to borrow more than it can afford.

"It's not our role to dictate public policy," said Ray Murphy, senior credit officer at Moody's. "We just want the state to get back to the point where they have a balance."

There is, however, one policy discussion in which Wall Street is eager to engage. It is the topic that most lawmakers, despite all their talk about trying to please Wall Street, have been reluctant to take on yet in a meaningful way: structural reform.

California's credit ratings have been low for nearly a decade, in part because of a budget that is overly reliant on taxes on stock market gains and other volatile sources. In boom times, it results in a windfall. But when the economy goes bust, so do state coffers.

Analysts said that reforming the tax law and other key parts of California's budget process -- a grueling task rife with political pitfalls -- is the best way for the state to return to the days of 1991, when it had an AAA rating from Standard & Poor's, the highest the firm gives.

"This is the time for them to talk about structural reform," Cohen said. "But I haven't heard a lot of talk about it."

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