Treasurer Warns of Cash Crisis

By Evan Halper

Oct. 22, 2003 12 AM PT

Times Staff Writer

State Treasurer Phil Angelides on Tuesday called on the incoming governor to immediately develop a strategy to keep the state solvent into next year, warning that legal challenges to plans to borrow money are putting California at risk of a cash crisis.

Angelides said Gov.-elect Arnold Schwarzenegger may have only weeks to take decisive action.

“There must be a Plan B put on the table now to balance the current fiscal year budget,” Angelides said. “The alternative is to hope on a wish and a prayer that everything turns out OK.”

Schwarzenegger is said to be considering bringing a proposal to sell bonds to the ballot for voter approval, thereby avoiding legal challenges. That option would give the governor little time, Angelides said, because the Legislature would have to approve the ballot measure by early December so it could be voted on in March. The treasurer said that waiting until the next election would put the state at risk of running out of cash when loans come due in June.

The treasurer also called on the Schwarzenegger team to have an alternate plan ready that would balance the budget without borrowing at all in the event the lawsuits are lost or prolonged or the voters reject the bond proposal.

A spokesman for Schwarzenegger declined to comment on the specific warnings Angelides made in a letter to the governor-elect. But he noted that Schwarzenegger has already installed a budget team to find solutions, and that a plan to bring the state to fiscal health will be presented in the coming weeks.

Other Republicans discounted as politically motivated the warnings from Angelides, who is widely expected to run for governor himself in 2006.

“We recognize this for the political stunt that it is,” said Peter DeMarco, a spokesman for Republican Assembly Leader Dave Cox of Fair Oaks. “It seems the treasurer needs to remember his campaign is four years away and he needs to do the job to which he was elected, which is selling these bonds.”

But financial analysts on Wall Street said the new governor would be well served by following the treasurer’s advice and taking decisive action fast.

The current year’s budget includes about $18 billion in borrowing. Already, a Sacramento Superior Court judge has blocked $2 billion of it as unconstitutional. The state had hoped to sell that amount in bonds to cover its annual payment to the pension fund for government workers, thereby freeing up money to balance the budget. But that violates a provision in the state Constitution that prohibits borrowing large amounts to pay routine expenses, the judge declared.

Angelides and others are expressing concern that the same argument could be used to block a planned bond sale that was the linchpin of this year’s budget agreement -- $10.7 billion in “deficit bonds” that would be sold to pay off the shortfall accumulated through June. The Pacific Legal Foundation is suing to stop that bond sale on constitutional grounds.

If the bond sale falls through or the litigation drags out, Angelides said, the state would risk running out of cash in June, when repayment of $13 billion of other short-term loans taken out earlier this year is due.

That scenario could be avoided if voters approve the bond sale in March. Schwarzenegger has hinted strongly that he intends to bring any major borrowing to plug the deficit before the voters. To get the borrowing proposal on the ballot by March, Schwarzenegger would have to call a special session of the Legislature within about the next six weeks.

Republicans agree with the treasurer on at least that much.

“If you feel you have to get these to a vote of the people, it probably should be done soon,” said Assemblyman John Campbell (R-Irvine), one of many advisors to Schwarzenegger on the budget. “I’m not sure the decision to do that has been made.”

Campbell questions whether the bonds are in as much trouble as Angelides seems to imply. “I’m not quite convinced the state is going to lose its case,” he said, adding there could be a settlement that resolves the issue.

Angelides warned that it would be risky to take the chance without a backup plan in place. “The financial and investment community needs to see how the state is going to balance its books and pay its obligations,” he said.

Wall Street analysts agreed that the state is in a precarious financial situation and quick action is needed, but expressed confidence that the problem would be addressed before the state goes broke.

David Hitchcock, director of public finance ratings at Standard & Poor’s, said that even if the deficit bonds aren’t sold by the end of the fiscal year, the state could avoid running out of cash if it establishes a credible financial recovery plan by then.

He said that, with a plan in place that Wall Street is comfortable with, the state probably could turn to a strategy used in the early ‘90s: rolling over its short-term loans into the following year -- at a hefty cost to taxpayers.

But he warned that there is a limit to how much of that can be done, and California is nearing it. The state is getting close to its borrowing cap with the banks, and the new governor would face a deficit of up to $25 billion if the bond sale falls through and he moves ahead with his promised cut of car registration fees.

“You’re never sure when the market is going to lose confidence,” Hitchcock said. “When it happens, it can happen suddenly, like a run on the bank.”

David Blair, a bond analyst at Nuveen Investments, warned that not having enough cash on hand to pay off the $13 billion due in June would raise anxiety among investors, putting the state at risk of another credit downgrade. Standard & Poor’s already lowered California’s rating to just above junk bond status over the summer.

The Schwarzenegger team is believed to be considering one more option: abandoning the deficit bonds, which would be paid back over five to seven years, and instead folding more of the accumulated deficit into a much bigger bond offering that would be paid back over 30 years.

There is debate over whether there would be enough investor interest in such a large long-term bond issue, which would cost the state billions of dollars in interest. Analysts also caution that the short-term relief it would provide would also reduce the state’s fiscal flexibility for decades as it paid the bonds off.

“Practically speaking, you could probably do it,” Hitchcock said. “Whether it is wise or not is another question.”