California Wont Default – US-FOREX.US
California’s ongoing struggle to close its budget gap may cause headaches for those collecting IOUs from the state. But investors holding California’s 59 billion in general obligation bonds shouldn’t worry, say some municipal market participants. The state may stiff everybody else, but it’s unlikely to bilk bondholders. Issuing IOUs may seem like a warning of worse to come, and even if California closes its 26 billion gap soon, declining revenues mean another shortfall is likely to hit later in the year. Bondholders may be safe for now, but what about then? The federal government, apparently willing to let the CIT Group
fail, may be less likely to support California than many think .The state’s financial mess has some predicting a default. One of the more prominent voices in this crowd, Martin Weiss, president of Weiss Research, correctly warned of troubles at Bear Stearns, Lehman Brothers
and Citigroup
. Weiss sees spending cuts to balance California’s budget leading to declining tax receipts in the near future, a series of downgrades from rating agencies, a refusal from the Obama Administration to bail out the state and then a default. If California can use IOUs to pay other creditors, Weiss says, it can pull the same trick with bond payments.But there’s another way of looking at the IOUs: Handing them out should reassure bondholders. It conserves cash to make interest payments at the expense of nearly everyone else, says Robin Prunty, a director of Standard & Poor’s public finance group. It would be a different story if the state paid interest on its bonds with IOUs, she said. The state’s constitution, after all, puts education first in line for claims on revenue and bonds second. All other spending ranks lower . California’s debt expenses look relatively low, argue Mustafa Chowdhury and Marcus Huie, fixed income analysts at Deutsche Bank
. In a recent research note, they counted 5.1 billion in interest and principal payments for the fiscal year, against expected revenues of 89 billion-a figure likely to shrink. The two analysts also believe the Obama Administration would come to California’s rescue to avoid a default. Municipalities rely on constant access to credit markets, and letting the largest issuer of municipal debt default would be disastrous for cities and states and raise their financing costs. Philip Condon, a well-known player in municipal markets and head of municipal bond portfolios at Deutsche Bank’s asset-management unit, is sure California won’t default on its bonds. He can, however, imagine a scenario in which the state misses a payment on its revenue anticipation notes, short-term securities held by money market funds that lack the legal claim of bonds. It would be like a cry for help. “Not paying notes would certainly get the federal government’s attention,” he says. “But I don’t think it’s going to happen.”