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California's bond ratings don't reflect reality

March 26, 2009|GEORGE SKELTON

FROM SACRAMENTO — Message from state bond investors to Wall Street credit raters: Your ratings aren't credible.

"The quality of their ratings is below junk status," says state Treasurer Bill Lockyer.

Lockyer, for the past year, has been on a crusade against what he calls the "rip-offs" and "conflicts of interest" of all three major bond-raters: Standard & Poor's, Moody's and Fitch.

"Ratings should have something to do with risk -- with the likelihood of losing your money," Lockyer says. "Otherwise, what's the point?

"They know there's no risk in a California bond. We've never defaulted and we're never going to. Not once has a bond investor failed to get what's owed in full and on time."

Lockyer has made virtually no progress selling his view to the rating agencies. But it seems bond buyers need no convincing. Apparently they don't see much point in the ratings either, except to signal how much interest the state will be forced to pay.

Shortly after California's bonds were downgraded by rating agencies to the lowest of any state, investors snapped up the state's new offerings so fast this week that selling had to be halted prematurely. Hoping to peddle $4 billion in infrastructure bonds in three days, Lockyer's shop sold $6.5 billion in less than two.

It was the largest long-term, general obligation bond deal in the nation's history, according to the treasurer's office.

"There certainly seems to be an investor appetite for California bonds," Lockyer says. "People understand that California is going to be here next year, unlike some corporations."

The interest rates were attractive, especially given the current shortage of havens for investment money. These yields will be tax-free and range from 3.2% annually for four-year bonds to 6.1% for 30-year maturities.

This is an area far from my field. For expertise on bonds and markets, I turn to Times business writer Tom Petruno. He wrote Wednesday about the "ravenous investor demand" for California's bonds, noting that with federal income taxes expected to rise "for the well-heeled, high tax-free yields are hard to resist."

But I do know this much: When financial failures such as American International Group Inc. enjoy far better credit ratings than the state of California, the system stinks.

In 2005, amid scandal, AIG's rating was lowered from AAA to AA. At that time, California's was hovering around A. AIG didn't fall to the A level until September as it was about to implode and was being handed the biggest federal bailout in U.S. history.

Lehman Bros. was rated A until one month before it collapsed.

"Lehman's gone, we're still here," Lockyer says, questioning the once-similar ratings.

"The agencies were rating thousands of those goofy derivatives that have cost us trillions of dollars triple-A, while we were A-plus."

This is why it matters: Each little tick up or down the grading scale costs money, either for investors or bond sellers. Sellers means taxpayers when it involves state bonds.

California's latest downgrading -- from A-plus to plain A -- means higher interest rates of 0.15%, according to the treasurer's office. That doesn't sound like much, but it translates into roughly $213 million for this week's bond sale, officials preliminarily project. That would pay a few teachers.

For California's $61-billion backlog of unsold, voter-approved bonds, that could amount to about $2 billion in added interest.

Most states are rated either AA or AAA. California shared the lowest rating with Louisiana until we got shoved lower.

The credit raters' rationale is California's virtually dysfunctional budget system.

In downgrading the state in early February, S&P wrote that "divisive deliberations" between the Legislature and Gov. Arnold Schwarzenegger, plus the two-thirds majority vote requirement, were "frustrating meaningful progress on solving the projected budget shortfall."

But when a $42-billion budget-balancing deal was enacted soon afterward, S&P didn't restore the previous rating.

Moody's and Fitch last week also lowered California's rating, citing the state's still-perilous fiscal situation. Fitch noted that the state's deficit-reduction plan hinges on uncertain voter-approval of some ballot measures in May.

But so what? The rating agencies have always ignored a basic fact: Not only has California never defaulted on a bond, state law won't allow it. Bond-holders are second in line for all state revenue after schools. They rank ahead of the state payroll, prisons, poor folks . . .

"California's not going to go out of business. They're not going into default. They're going to pay you back," says John Cummings, executive vice president of Pacific Investment Management Co. in Newport Beach. "But they really do need to be on time with the budget. And they've got to change that two-thirds majority vote to get it down to 55% or 50%."

Lockyer complains that rating agencies force municipal bond sellers -- state and local -- to meet higher standards than corporations because of outdated rules. "Taxpayers should be treated the same as corporations."

Better, I'd say, given the recent epidemic of bankruptcies and taxpayer-funded bailouts.

Wall Street bond-raters, Lockyer asserts, are catering to investor-pals "who like phony risks."

Municipal Market Advisors, a consulting firm, reported last year -- even before the economy tanked -- that muni bonds rated A defaulted 10 times less than corporate bonds rated AAA.

California bond buyers apparently have gotten the word, no thanks to any rating agency.

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george.skelton @latimes.com

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