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U.S. Attorney General Eric Holder leads a news conference to announced that the United States is bringing a civil lawsuit against the ratings agency Standards & Poor's and its parent company, McGraw-Hill Companies, over its pre-fiscal crisis bond ratings.
That's what Matt Nesto and Jeff Macke at Yahoo Finance think, and you can watch them talk about it here.
The timing of the Justice Department's lawsuit against the credit rating agency — alleging that S&P fradulently overrated numerous mortgage-backed securites in the lead-up to the financial crisis — is a tad suspicious, surfacing as Washington is about to enter what could be a fractious debate over sequestration.
Those automatic cuts could begin March 1 if Congress doesn't resolve or delay them. And hanging over the process, like Damocles' sword, is the threat that S&P in particular will downgrade U.S. debt again, repeating an action that it took after the debt ceiling debate in 2011.
The Justice Department filed its 124-page complaint — which contains enough securities-market abbreviations (RMBS, CDO, SVP...) to thrill even the most jaded of finance geeks — in Los Angeles late Monday. Various reports suggest that state attorneys general will follow suit, with California's Kamala Harris and New York's Eric Schneiderman leading the charge.
California Gov. Jerry Brown speaks in support of Prop. 30 at a rally of UCLA students on campus, Oct. 16, 2012. The passage of the ballor measure in combination with fiscal discipline has led ratings agencies to re-examine California's debt.
Hot on the heels of lowering Illinois' general obligation (GO) bond debt one notch, from "A" to "A-", Standard & Poor's raised California's GO debt to "A" from "A-".
So California is now the second lowest rating U.S. state, among those whose debt S&P rates.
It was S&P's first upgrade for the state since before the financial crisis.
I talked to California Treasurer Bill Lockyer after the announcement, and he credited the combination of Prop 30 — the ballot measure passed last November that raised sales taxes and income taxes on wealthy Californians — along with improved fiscal discipline for prompting the upgrade.
Another agency, Fitch Ratings, is also keeping an eye on California's improving finances. Doug Offerman, an analyst I spoke with last year, wouldn't put a timetable on a possible upgrade, but he did indicate that Fitch likes the math Prop 30 delivers:
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San Bernardino City Hall. Was bankruptcy really the best move for this California municipality?
Moody's, the investment rating agency, has just released some commentary on "speculative" credit in the local-government sector. This is credit that has been downgraded to non-investment-grade status. It's basically junk — or, if you prefer, "high yield." The risk of default is higher, but the interest rate is also higher, making for a beefier return.
Moody's has been focusing for a while now on the worsening fiscal situation for the cities whose debt it rates, with special concentration on California. It recently placed a number of municipalities in the state on review. The agency says that there's a new factor it's watching carefully. From the report:
Some distressed governments have confronted the plethora of economic, financial, and managerial problems by choosing to discriminate among their outstanding obligations. Lack of willingness to pay debt service is emerging as a new theme in public finance. Although it’s not expected to become a widespread practice, even among speculative-grade issuers, there are several recent examples of this development.
The City of Stockton, CA has struggled for many years to control costs efficiently amid a severely weakened local economy, ineffective negotiations with its bargaining units, and management’s decision to take on the costs of dissolving its redevelopment agency. In June 2012, Stockton filed for Chapter 9 bankruptcy protection and adopted a budget that suspends payments on some lease and pension obligation bonds.
Another big rating agency, Standard & Poor's, is also keeping an eye on cities in California. I recently talked with Gabriel Petek, an S&P credit analyst. He indicated that S&P is also reviewing the California cities in its ratings universe and echoed Moody's concern about the "lack of willingness to pay" matter.
But he also tackled the question of whether it makes sense for financially distressed cities to enter bankruptcy, as three California cities — Stockton, San Bernardino, and Mammoth Lakes — have this year. (More may be on the horizon: Atwater, near Stockton, has declared a fiscal emergency, and things don't look too good in Compton.)
"In a case where an entity is genuinely insolvent, there may not be a lot of options," he said. This is effectively what happened in San Bernardino, where unlike Stockton, there was no pre-bankruptcy mediation process, now mandated by state law. The fiscal crisis in San Bernardino was so dire that the city proceeded directly to Chapter 9.
But as far as Petek is concerned, that was an extreme case. "Bankruptcy should be avoided at all costs," he said. "Most bankruptcies seem to exceed long-run and near-term benefits."
Case in point? Vallejo, the Northern California city that declared bankruptcy in 2008 and emerged in 2011, racking up tens of million in bankruptcy costs along the way. The Vallejo experience led to AB 506, the mediation legislation that created the process that was first tried, but that ultimately failed, in Stockton. Vallejo's dire financial straits have been much analyzed, perhaps most prominently by Michael Lewis last year in Vanity Fair.
"Other parts of Bay Area are in recovery, but Vallejo is languishing," Petek said. "They haven't had access to capital markets. Older cities need to make investment in infrastructure, and the only way to do that is via access to capital markets. So cities that may be in Vallejo [and Stockton's] position should be forewarned. It will be a costly drawn-out process."
So if bankruptcy is a bad move for California cities under financial stress, does mediation, even though it failed in Stockton, represent a vaible option?
"We haven't seen so far that it's functioned that way some policymakers had hoped for or envisioned," Petek said. "The problem starts with initial negotiations. Multi-year contracts with labor, securing compensation, don't enable management to deal with changing conditions."
These labor contracts have become a sticking point for numerous older, stressed-out California municipalities. Negotiated when city budgets were flush, they've become onerous since times have changed and revenue bases have collapsed due to the housing crisis and high unemployment cutting into sales taxes. Labor costs are gobbling up 80 percent of budgets, leaving city managers with extremely limited flexibility.
"Cities are service providers, but some are operating in an environment where you can't raise revenue due to Proposition 13, and some of these are cities that also locked in multi-year labor contracts," Petek said. "They removed the part of the budget they had discretion over."
Petek calls this "fiscal handcuffs." Because Proposition 13 prevents any latitude on raising property taxes and some city workers have been inflexible in renegotiating contracts, municipalities are staring down the difficult choice of declaring bankruptcy and ending up like Vallejo or muddling through and trying to slash everything but essential or non-negotiable services, degrading quality of life in their cities.
Petek doesn't let city managers off the hook, however. He said that many made decisions prior to the end of redevelopment and the loss of $6 billion painted cities into a corner. Redevelopment wasn't intended to plug budget gaps. But in San Bernardino, redevelopment money became a "lifeline," according to city officials, enabling the municipality to maintain it aging infrastructure.
The fiscal collapse of several cities in California caught the bond markets off guard. Over the past year, Moody's, S&P and others have been taking a much closer look at why cities that didn't outwardly look like major credit risks suddenly got on fast tracks to Chapter 9. For the most part, there's no reason to expect a deluge of bankruptcies. But for Petek and others, there are good reasons to drill deeper into what's really been going on with the finances of Golden State municipalities.
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CANNES, FRANCE - NOVEMBER 03: US President Barack Obama is welcomed by the French President Nicolas Sarkozy to the G20 Summit on November 3, 2011 in Cannes, France. World's top economic leaders are attending the G20 summit in Cannes on November 3rd and 4th, and are expected to debate current issues surrounding the global financial system in the hope of fending off a global recession and finding an answer to the Eurozone crisis. (Photo by Dan Kitwood/Getty Images)
The world's ninth largest economy is now joining the first largest in the unhappy doghouse of Standard & Poor's downgrades. Just as the U.S. was busted down from AAA (S&P's highest rating) to AA+, so, too will France see its "credit score" fall.
A downgrade by S&P signals that the latest pledges by European leaders to clamp down on deficits and step up cooperation won’t be enough to end the region’s debt crisis and curtail the rise in France’s borrowing costs. The country’s benchmark 10-year bonds now yield 130 basis points more than debt of AAA rated Germany.
A downgrade of France may further complicate Europe’s efforts to stem the crisis by threatening the rating of the region’s bailout fund. The European Financial Stability Facility, which is funding rescue packages for Greece, Ireland and Portugal partially with bond sales, owes its AAA rating to guarantees from the euro region top-rated nations. A French downgrade may prompt investors to demand higher rates on the fund’s debt.