The much-maligned state of California has finally received some good news: a $2.5 billion spike in tax-revenue. This unanticipated windfall — an unexpected shot in the arm for a state struggling to close its imposing budget shortfall — was a result of an increase in personal income tax collections, which are running $2.3 billion higher than projected for the first 10 months of the year, according to California’s Legislative Analyst’s Office.
Over the past few years we have attempted to dissuade California investors from liquidating their general obligation bonds at depressed prices as media fear mongers were equating the state’s problems with the plight of Greece. (“California: Strained But Strong,” “California Struggles But Holds On.” )
In a report released last week, Standard & Poor’s reiterated that “California is not Greece.” Gabriel Petek of S&P said, “We believe that some of the perceptions about the similarities between California and Greece noted in the media do not hold up to closer scrutiny.”
The report pointed out that California’s gross domestic product was $1.9 trillion in 2010, as opposed to Greece’s $305 billion. The state’s real GDP growth rate is projected at 2.9% in 2011, which is in stark contrast to Greece’s negative 3.5%. Even more telling for bond investors is that Greece’s debt-to-GDP ratio is 153% vs. California’s 4.1% government debt to gross state product.
California boasts one of the top 10 largest economies in the world and, according to S&P, its capacity to pay its debt, despite its well publicized budget problems, remains strong.
Nevertheless, it is clear that the state is not out of the woods yet and difficult decisions still lay ahead.
Even if Gov. Jerry Brown is successful in his efforts to extend higher sales and personal income tax rates, the state will still be compelled to make major spending cuts, which would include government services and education.
In the meantime, bond holders can continue to be comforted by the fact that they are protected by the state’s Constitution, which requires payment of debt service, second only to school funding as a top priority. Today, California General Obligation bonds are trading in line with the debt obligations of most other states.
Although it is clear that economic and political challenges persist, the sanctity of general obligation debt will prevail and bond holders will be paid.