California’s Credit Rating Is Justifiably Poor

My colleague Len posted earlier about state bond ratings which I wanted to add to, particularly with regard to California. The bond rating agencies’ comments about California’s debt situation bear repeating:

Spokesmen for Fitch and Standard & Poor’s, which downgraded California bonds from A-plus to A in February, said the lower ratings reflected the state’s precarious financial condition, especially its reliance on one-time revenue, temporary tax increases and borrowing to balance its budget in the next two fiscal years.

Los Angeles Times columnist George Skelton thinks the rating agencies are being too hard on the state, however. In an L.A. Times article last week, Skelton pointed to strong demand for a recent state bond sale as evidence that the ratings are out of whack. California was hoping to sell $4 billion in infrastructure bonds over three days last week, but ended up selling $6.5 billion in two days.

But bond ratings are not meant to gauge demand for bonds; they are used to evaluate risk, especially relative to other bonds on the market. You can still have a situation where there is high demand for junk bonds. Indeed, some investors in difficult economic climates like this one may be willing to take on more risk in an attempt to make up for their previous losses.

The fact is that California has the most debt and most precarious budget year in and year out, so it should be no surprise that it has the worst credit rating of all the states. This means it has to pay higher interest rates on its bonds. The latest downgrade raised rates 0.15%, which will end up costing the state an additional $213 million for last week’s bond sale. If California sold its entire $61-billion backlog of of unsold bonds, that difference would end up costing the state an additional $2 billion in interest.

State officials like Treasurer Bill Lockyer complain that the rating agencies are unfairly punishing states like California, but the state is simply reaping what it has sown. It has taken many years of poor fiscal management to earn California the dubious distinction of worst credit rating in the nation. Rather than whining about the higher borrowing costs necessitated by the state’s poor credit rating, policymakers and state officials should try acting responsibly to improve California’s fiscal condition by ending the spending binge that has gotten the state into trouble in the first place. Doing so would improve more than just the state’s credit rating.