California: Too Big to Fail?

The Bond Tangent points to a Bloomberg piece declaring California Muni Bonds are priced for trouble:

“The spreads have widened and investors are getting much more compensation for California bonds,” said Paul Brennan, who oversees about $12 billion in municipal-bond funds for Nuveen Asset Management in Chicago. “There’s still a lot of ups and downs to come unless there’s some dramatic budget agreement that could change all that.”

As we can see below, yields on 10 Year California General Obligation "GO" Bonds have indeed increased, in a period in which the 10 year note has rallied ~200 bps.



In addition, California bonds have widened by a similar "relative factor" as compared to the entire GO Muni Bond Index.



In other words, the bonds are pricing in a chance of default (it now costs $400k to protect $10mm worth). Back to the article:

The nation’s most-populous state will run out of money to pay bills as soon as February unless lawmakers end an impasse over how to close the funding gap. California has the second- lowest credit ratings in the country because of perennial fiscal shortfalls and legislative gridlock.

Going back to The Bond Tangent... while some states and municipalities will have issues funding their budgets, California will make due. Why? For one... the negative stigma associated with a failure to make the payments.

More importantly though, it all goes back to the question of "too big to fail".

It is not difficult for me to see more smaller government entities going bankrupt. But one of the world's largest economies? People really need to get a handle on what this would mean.

I can't agree more...