Thanks to Newsweek’s July 28th cover story, “California in Crisis,” the Golden State’s political and economic problems are no longer a secret.
Since last Thursday, when Standard & Poor’s cut its credit rating on California General Obligation bonds from A to BBB, we have been inundated with e-mails from our west coast clients asking if they should dump their California bond holdings.
A Buying Opportunity
We think California residents should be buying, not selling. The yield on California G.O.’s has risen by approximately 30 to 35 basis points (from 5.00% to 5.35%) since the S&P downgrade. This means bonds that were trading at 100.00 can now be purchased for about 95 cents on the dollar. To put this into perspective, long-term insured California bonds are currently yielding approximately 5.00%.
California general obligation bonds are secured by the “full faith and credit” of the state. This pledge is supported by the state’s “ad valorem” taxing power. Ad valorem taxes are based on the assessed valuation of real property. California boasts some of the most valuable real estate in the country.
According to the state constitution, G.O. debt service is the second charge to the General Fund after monies earmarked for the support of the public school system and public institutions of higher education. Theoretically, this means bondholders will be paid before any other public purpose – including the governor’s salary. Current political machinations aside, this makes California State G.O.’s an extremely secure investment.
The Right Perspective
These important facts are being obscured by the adverse publicity attendant to the political stalemate with regard to the state budget, along with the upcoming recall vote in October.
By the way, according to Moody’s Investor’s Service, California is not close to having the highest per capita debt burden among the states. In fact, it ranks number 19.
We are old enough to remember the New York City crisis in the early ’70s. After the panic selling stopped and the smoke cleared, it turned out that the astute investors were buying, not selling. It should also be noted that the New York crisis was considerably more dire than the fiscal problems in California today.