Business analyst Mark Lacter joins KPCC once a week for an in-depth look at economic issues in Southern California.
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S&P downgrade

KPCC's business analyst Mark Lacter talks about last Friday's S&P downgrade mean California.

Steve Julian: On Tuesdays we talk about the latest business stories with Mark Lacter. Mark, will last Friday's S&P downgrade filter down to local or state bonds?

Mark Lacter: It’s quite possible Steve. S&P has said it's going to downgrade state and local governments that rely heavily on federal funding, and that could include California, L.A. and other municipalities in the state. So far I've seen downgrades for local investment funds involving Los Angeles and Anaheim because they’re heavily exposed to U.S. Treasury securities. But compared with what’s been happening in the stock market, these sorts of downgrades are pretty tame – and also pretty reasonable.

Julian: The main purpose of a ratings agency is to help investors, right?

Lacter: Yeah, help them determine the risk of a financial product, typically a corporate or government bond. In general, the lower the grade, the shakier the financial condition and the more likely the interest rate will be higher. That means whoever is borrowing the money is going to have to shell out more money in interest, which in the case of a government usually means increasing the size of the deficit.

Julian: Hasn’t this been a problem for California?

Lacter: It has. California has the lowest credit rating of any state (Standard & Poor's has it down to an A-minus, which is six notches below the highest rating), and as a result it has to offer an interest rate that's considerably higher than what's available for a best-rated security – kind of a risk premium that’s not all that different from what you'd find for a consumer loan. The ratings agencies have been saying that California's government is dysfunctional, and while the state probably doesn't deserve to have the absolutely lowest grade (there are lots of pretty horribly run states out there), and while a budget deal was worked out on time, it's hard to argue about their overall conclusions. Look at what happened during the budget battle, when Gov. Brown couldn’t get a single Republican vote to extend taxes.

Julian: So how do cities cope with the struggling economy?

Lacter: Well, on a certain level there’s not that much they can do. I was talking to L.A.'s budget director, Miguel Santana, yesterday afternoon and he was quite concerned about what the ripple effects of the S&P downgrade and what’s been happening in the markets. You have to be concerned - when folks are worried about losing their job or finding a new job or seeing their retirement money disappear in the stock market, they're not in any mood to take a vacation or buy a new car.

Julian: That's true whether you're in L.A. or Miami or Cleveland.

And in some ways, L.A. is a bit more vulnerable than other cities because it faces such a chronic deficit - that's the result of high labor costs and all those pension liabilities we've been talking about over the months. The shortfall for the city runs close to a half-billion dollars through the next three or four years, which wouldn't be a crazy amount of money if businesses were opening up in L.A. at a decent clip, and they were hiring at a decent clip.

But they're not, of course...

...and since there's so little appetite for raising taxes, the city is stuck with that old refrain: too much money going out and not enough money coming in. And that's where the ratings agencies come into the picture and determine how risky it is to lend money to the city of L.A. Generally, they’re erring on the side of lower ratings, perhaps because of all the triple-A ratings they handed out to those risky subprime mortgage securities a few years ago. So, as an example, S&P has given the city of L.A. a double-A-minus rating, which might not sound too bad, but is actually quite a bit lower than the highest rating you can get. Any further downgrade would move the city into only so-so territory and would set the stage for higher borrowing costs. And every city is vulnerable, especially if growth continues to slow and those deficits keep piling up.

Mark Lacter is a contributing writer for Los Angeles Magazine and writes the business blog at LA