California Budget Balanced... For Now

NY Times reports that California Legislature finally approved a budget to close the $26 Billion Gap.

The budget contains a vast array of spending cuts that will soon be felt throughout the state. The K-12 education budget, which also includes community colleges, lost $6.1 billion from its roughly $58 billion base, and higher education took a $2 billion hit.

There were accounting tricks, like $1.2 billion that will be saved in a one-time deferment of state worker paychecks for one day, moving them into the next fiscal year.

Tough, but at least by screwing over the next generation of intellectuals, California has solved the budget crisis for good... right? Nope. Not even Arnold and California's legislative leaders think that's the case. Business Week reports:

"We are still in troubled waters; there are still uncertainties," the Republican governor said. "We don't know how much longer our revenues will drop. We don't know if we may not be back in the next six months to make further cuts."

Legislative leaders said much the same thing.

"It's entirely likely we will ultimately see further declines in revenue, which will almost certainly require further budget action," said Assembly Minority Leader Sam Blakeslee, a Republican from San Luis Obispo.

Source: NY Times

California Struggles Continue

Housing downturn in the epicenter of the subprime fiasco = high unemployment (per The Big Picture):

“California continues to bleed jobs, more so than most of the rest of the country. The national unemployment rate for May was 9.4%, and only four states had higher jobless numbers than California: Michigan at 14.1%, Oregon at 12.4% and Rhode Island and South Carolina, tied at 12.1%.

Housing downturn + high unemployment = loss of revenue for the state = massive budget deficit (per NY Times):

The state of California is facing a multi-notch downgrade of its debt if it fails to resolve its budget woes, Moody’s Investors Service said Friday.

The warning follows a similar one from Standard & Poor’s, which put the state on a negative credit watch earlier this week because of its dismal financial condition.

“If the legislature does not take action quickly, the state’s cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July,” Moody’s said. “Lack of action could result in a multi-notch downgrade.”

Threat of downgrade = widening spreads relative to the broader Muni index:



Widening spreads = feedback loop as higher interest payments means it costs more for California to finance their debt. So, is California toast? Still highly unlikely. DerivActiv (via The Bond Tangent)

There's still very low default risk in owning California bonds. California still has enormous amounts of structural protection for bond holders. But that being said, situations where the voters gave, depending on your interpretation, but a fairly clear message, I think, that tax increases are off the table. So it should have been able to reduce the polarization of that legislature and facilitate a quicker budget solution, but it just has not been the case. It's almost been the opposite. Now the legislature seems to not know what to do at all. The Governor has taken two-year cash flow borrowing off the table for this year, which means that really the focus has to be even more on cost cutting.

So enjoy that extra 50 bps of yield, but expect to pay for it in the form of volatility.

Source: Barclays