Sacramento -- The state's protracted budget impasse is wreaking havoc on California's bond investors on Wall Street, creating losses that may make them reluctant to lend money to the crisis-ridden Golden State in the future.
Collectively, the $11 billion in bonds issued last month by the state have lost as much as $68 million in trading market value, according to calculations based on quotes provided Wednesday. Already, some of the nation's largest fund management companies, including Fidelity and Vanguard, have refused to buy any more state bonds.
"This is yet another sign that California's financial standing is being hurt," state Controller Steve Westly said Wednesday. "People need to know, Republicans and Democrats alike, that Wall Street is running out of patience with California."
If the state's financial problems continue to alienate more of the major bond purchasers, then it would make it more difficult -- and expensive -- for the state to borrow in the future.
That would mean even more of the money California is borrowing through bond sales would have to go toward interest payments, depriving the state of cash for critical programs that are already on the chopping block as a result of the budget crisis. That's very bad news for a state that is hoping to finance its way through cash shortages and deficits with at least three more bond issues this year, totaling $16 billion.
Adding to the uncertainty, major credit rating agencies have warned that they may downgrade California's debt if the budget mess is not resolved soon, which would further raise costs and also trigger cash penalty payments to the state's investment banks. Though it is an apocalyptic scenario, if California' debt rating were dropped to junk status it would be legally off-limits as an investment to most all mutual funds.
The Legislature and Gov. Gray Davis, administrators of the world's sixth- largest economy, have yet to come up with a balanced state spending plan to address a $38 billion deficit, now 24 days into the new fiscal year. The state is currently operating entirely on borrowed cash.
No one in the capital is ready to say just when the budget mess will be resolved. On Monday, liberal Assembly Democrats were overheard discussing ways to prolong it for political gain. Senators continue to work toward a budget deal, but key decisions remain to be agreed upon.
"We're about 75 percent there," said Sen. Jackie Speier, D-Hillsborough.
About $600 million more in cuts have been agreed to, including lower payments for Medi-Cal providers, she said.
A key sticking point between Democrats and Republicans has been whether the state would raise taxes to provide payments on another $10.7 billion bond issue planned for later this fall. Democrats want to raise tax revenues by $2 billion, but Republicans have steadfastly refused.
It now seems Republicans have won that battle. Instead, the budget will contain a complicated swap of sales tax and property tax between the state and local governments, providing that needed money from existing funds.
Still up in the air is whether the tax swap will be a half or quarter cent, Speier said. If it is only a quarter cent, then the bonds would be paid off over 10 years instead of five.
All sides agree that whatever budget passes this year would leave the state as much as $11 billion in debt next year.
"It's hard to do anything else without tax increase," Speier said. "That is the problem with our inability to run a state budget like we would run a family budget. We have this disease of putting it over, hoping the economy will turn around."
That, combined with the uncertainty surrounding Davis' tenure in the face of a recall election, is driving interest rates on bonds up, and prices down.
Investors who buy and hold their bonds to maturity and redeem them are still entitled to be fully repaid, plus the guaranteed interest rate. But on the bond market, where traders buy and sell debt securities many times before they are redeemed, and which supplies the lion's share of cash to the state, the value of California's debt is dropping sharply.
When California issued $11 billion in debt last month, it agreed to pay back bondholders in full, plus 1.13 percent interest, which is called yield. In the bond market, original buyers then turn around and sell those bonds to other buyers.
But California's shaky outlook is causing new bond buyers to demand as much as 1.75 percent yield. Because the state will only pay the original 1.13 percent of that interest, the remainder has to come out of the pockets of bond traders who are trying to sell them.
"The after-market performance has not been good," said one senior banker with a major Wall Street firm that was involved in the deal. "Frankly, the answer we're hearing from (bond) buyers is: 'We're going to wait and see what happens with the state' before making further investments."
What is more remarkable about the drop is that government bonds are supposed to be relatively staid investments, with little or no fluctuation, and certainly not precipitous declines in value. Money managers include them in funds to provide stability. So when they lose considerable value, it is all the more shocking.
Not surprisingly, none of the major Wall Street and money management firms that has bought the bonds has been willing to talk about its investments.
"There are people who are put off by all the noise," said one trader at a Wall Street firm, who spoke on condition that he not be identified.