June 11 (Bloomberg) -- California Governor Jerry Brown, running for an unprecedented fourth term, says that if he can curb his fellow Democrats’ spending dreams, the most-indebted state may win its highest credit rating in five years.
Brown and lawmakers are pushing separate versions of a budget for the fiscal year that begins July 1. Democrats who control the legislature want to spend more of the surplus money California is raking in from capital gains and $7 billion of higher income and sales taxes that voters approved in 2012. Brown says the state must first put aside money for a rainy day and pay down its debts.
“Our credit rating is going up,” Brown, 76, told reporters in Sacramento last week after he won a primary election to advance to the general in November. “If we get the right kind of budget, it’ll go up again.”
In the time since Brown took office in January 2011, California has earned higher marks from Fitch Ratings and Standard & Poor’s. The companies cited his financial repairs to a state whose fiscal turmoil once drew comparisons with Greece. Political dysfunction in the previous decade left lawmakers unable to fix deficits that exceeded $100 billion combined.
The most-populous state’s borrowing costs last month fell to the lowest since 2008 after Brown proposed a reserve against leaner economic times. He also wants to finance unfunded pension costs and pay off what he calls a “wall of debt” that former governors racked up in balancing prior budgets.
Investors demanded as little as 0.35 percentage point of extra yield last month to buy 10-year California obligations instead of top-rated municipal bonds, according to data compiled by Bloomberg. That’s half the level of a year earlier and down from a peak of about 1.7 percentage points in 2009, when the state resorted to IOUs to pay bills.
While the lower yield spread means it costs California taxpayers less to borrow, the relative bond costs are still more than triple what investors demand for top-rated states such as Virginia.
The tax increases that Brown championed have stoked investor interest in California tax-exempt debt. Bonds of California issuers have earned 6.4 percent this year through June 9, compared with 5.6 percent for the entire $3.7 trillion municipal market, S&P Dow Jones Indices show.
“The governor has done an effective job at keeping the legislature from spending the state’s recent operating surpluses,” said Michael Johnson, managing partner of Gurtin Fixed Income Management LLC, which oversees $7.5 billion in Solana Beach, California.
A stronger rainy-day fund “will likely have the effect of lowering yields as investors and the ratings agencies will undoubtedly react positively,” he said.
Brown has proposed spending a record $107.8 billion for the fiscal year beginning July 1. Democrats, relying on higher revenue estimates from the nonpartisan Legislative Analyst’s Office, have drafted budgets that spend $2 billion more than the governor’s. The Democrats also say more money may be available because Brown’s estimates on some costs, such as adding more people to state-run health care, are too high.
Democratic lawmakers want to increase spending on social programs such as subsidized housing and childcare, and raise pay for in-home care workers.
“Establishing a solid budget reserve and addressing the state’s financial obligations, including pension liabilities, are top priorities,” said Senator Mark Leno, a San Francisco Democrat who is chairman of the Budget and Fiscal Review Committee. “At the same time, we must balance this financial prudency with key investments in programs that improve people’s lives and stimulate the economy.”
Legislators have until the end of June 15 to send Brown a budget. They won’t get paid for each day they are late. The governor must sign a plan into law by July 1.
Credit-rating companies have criticized California for its failure to set aside money when the economy is booming and for relying too much on volatile capital gains to pay for general-fund spending.
California’s general-obligation bonds have an A1 rating from Moody’s Investors Service, the fifth-highest rank. S&P grades them A, one level lower than Moody’s, with a positive outlook -- often a precursor to an upgrade. California hasn’t had an S&P rating above A since 2009. Only Illinois has a lower rating from both Moody’s and S&P.
Brown first served as governor for two terms from 1975 to 1983. He won a third term in 2010 and is running for re-election against Republican Neel Kashkari, a political newcomer who ran the federal bailout of the U.S. banking system. A University of Southern California Dornsife/Los Angeles Times poll released June 1 found Brown would beat Kashkari, 55 percent to 27 percent.
At Brown’s urging, Democrats agreed in May to put a measure on the November ballot asking voters to amend the constitution to require the state to set aside 1.5 percent of general-fund revenue each year, as well as capital-gains taxes that exceed 8 percent of the general fund.
He also proposed a plan to begin financing the state’s $74 billion gap in teachers pensions.
“There is billions of dollars floating around over in the capitol and we are going to have to rein all that in,” Brown said.
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