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Q

Given the news that I saw on TV, is it possible that if the state of California runs out of money – as it claims it may – that it will not be able to continue to pay the interest on the state general obligation bonds?

A

James A. Klotz responds:

While California’s budget travails are troubling, they are not a reason to panic.

California’s constitution requires that state general obligation debt service be paid prior to other state expenditures, excepting state aid to public schools.

California has a history of budgetary unpredictability, with fiscal year 2009 following form. Weak sales and income tax collections, along with the state’s poor housing market, combined to produce an estimated $17.2 billion deficit for fiscal year 2009.

After difficult negotiations with the state legislature, Gov. Arnold Schwarzenegger recently signed a $103.4 billion budget, more than 12 weeks into the new fiscal year, that relies on certain one-time fixes to eliminate the deficit. The budget will also require issuance of $7 billion of Revenue Anticipation Notes (RANs) to provide adequate cash flow during low-revenue points.

States have broad economies and large, diverse revenue streams providing adequate resources to meet debt service needs. We believe the last default by a state government occurred during the Civil War.

California’s credit rating is already “A+” by S&P, one of the lower state ratings, reflecting the annual budget battles that rage there.

While fiscal year 2009 and beyond are likely to be difficult financially, California can be expected to take the necessary steps to honor its debt commitments as it has always done.