BA I LARD , B IEH L & KAI SER
A Topic Paper: February 2003
Eric Leve, CFA
Senior Vice President, Global Fixed Income
Introduction
n 1994, on the heels of the worst
recession in a decade, California’s
accumulated budget deficit ballooned
to $3.85 billion. Along with this deficit,
structural budgetary constraints and
overly optimistic expectations prompted
Moody’s Investor Services (Moody’s) to
downgrade California’s general
obligation debt to a rating of A1.1 This
was the lowest credit rating California
had held since it came out of the Great
Depression. As the 2003 – 2004 budget
process begins, California is faced with
an expected deficit of $34.6 billion.
Similar budgetary handcuffs to 1994’s
make Governor Gray Davis’s
responsibility to balance this budget
more difficult than at any other time
since the Great Depression. Recently,
the state’s financial condition pushed
Moody’s to again downgrade
California’s credit rating to the
unprecedented level of A2. This paper
will try to make sense of the fiscal
situation and the budget process. We
will explain the impact of the budget
crisis on the state itself, its taxpayers
and residents, and on those who invest
in its municipal debt.
1 See table on page 4 for explanation of ratings
definitions.
Economic Backdrop
alifornia’s economic situation has
faltered more spectacularly and more
dramatically than that of the country
as a whole. Anecdotally, individuals have
perceived and heard about weakness in
home pricing and the local economy’s
dependence on the technology sector. But
how has that translated into the largest state
surplus in California’s history becoming the
largest state deficit in the Union’s history?2
Much of the answer lies in the hubris of the
bull market and the fiscal structures built up
during it.
The bottom line for state revenues is simple;
in good times they rise and in bad times they
fall. During the