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              California's Budget - Schwarzenegger's Achilles Heal?

In an article from Fortune and CNN, it identified that April marked the first time since December
2001 that Moody's revised its outlook for the U.S. state-government sector to negative and in
October the ratings agency put out a new report predicting states will face harder times as the effects
of the credit crisis and economic downturn continue to set in.                                                             

Already states are facing larger-than-normal budget shortfalls, which could mean, among other
things, a reduction in services for residents and a greater risk of a credit rating downgrade. For
example, New York is looking at a whopping $47 billion deficit over the next four years. California
is $3 billion in the hole this year and growing and has a potential $28 billion shortfall over 2 years.

The National Conference of State Legislatures has even begun appealing for states to get their
share of bailout money. (Even cash-strapped cities like Philadelphia and Phoenix are hoping for
a piece of the pie.)

Yet, as bad as it looks, Moody's predicts most states will get through this period without a serious
deterioration in their credit quality. "States are stronger in and of themselves," said Edith Behr, vice
president and senior credit officer at Moody's. "It has everything to do with being able to reduce
expenditures and increase revenues."

These tools, like raising taxes or cutting spending, are why states generally have higher ratings than
corporations. No states' General Obligation Bonds rank below A1, which is investment grade and
only four notches below the triple-A "gilt edged" ranking.

The fact that states can't declare bankruptcy also supports their relatively strong ratings. That's one
key reason why states have a higher median rating than cities, which can file for bankruptcy protection
(as Vallejo, Calif., voted to do in May). What's good for states when it comes to easing their financial
woes can also end up meaning more hardship for their cities as states push expenditures down to
the local level.

Even with these advantages, Moody's has six states on negative outlook - Florida, Kentucky, Nevada,
Ohio, Rhode Island, and Wisconsin. Still, that's below the 13 states that were on the negative outlook
at the end of 2001, after the dot.com bust and the 9/11 terrorists attacks.

     

This time around, Moody's says many states are better prepared with rainy day funds thanks to record
revenue growth in recent years. Even so, states have plenty to worry about. Budget gaps are widening
and there aren't a lot of formal plans yet for filling the shortfall. The weakening economy is translating
into a decline in jobs which, in turn, means less corporate and personal income taxes. Adding to the
distress: consumers are spending less so sales tax revenues, which Moody's says accounts for about
one-third of state general fund revenue, are falling.

States also face obstacles specific to their economies. Florida, for example, is hurting from the housing
bust. Ohio is challenged by a downturn in manufacturing and concerns that tax reductions may weaken
the state. Heavy exposure to the financial services sector is hitting states like New York, New Jersey, and
Connecticut especially hard. Rhode Island is also reeling from a continuing decline in manufacturing jobs
 - its 8.8% unemployment rate as of September is the country's highest, according to the Bureau of Labor
Statistics.

Not all states are in bad shape. Nine boast triple-A ratings, including Vermont and Delaware, which have
healthy financial reserves and a history of strong management. Expect states that depend on natural
resource industries, like Alaska and Texas, to also fare better, Moody's says. But those states bolstered
by large reserves aren't in the clear, Behr says. They could see some added pressure as the price of oil
and gas drops.

Even some of the lowest-rated states, like Louisiana with its A1 grade, have something to be thankful for
over the holidays when it comes to propping up their bond ratings. On the Bayou there's a bright side with
almost no exposure to financial services, a dose of federal funding in the aftermath of Hurricane Katrina,
and plenty of oil reserves.  And for California, voters during the good times supported referendums that
along with private market forces will create $350 billion in infrastructure improvements along with
leading edge stem cell research, and with billions in private construction projects for hospitals to new
private building projects creating an estimated 5 million jobs through 2018.  See 
www.CaliforniaBusinessMinute.com  – NO SUGAR ADDED: A Positive Outlook for California.

For even further information, see:  'Pessimistic Assessment', 09-18-08 at the CalBizBlog,  the
financial issues facing our nation's cities.