Europe's Crisis is Keeping California Afloat

Europe's Crisis is Keeping California Afloat

Given California’s astonishingly–and unexpectedly large–budget deficit estimate of $16 billion, which may understate the actual shortfall, creditors might be expected to flee the state. However, Europe’s own debt crises, and growing uncertainty in Asian economies, are making California a relatively attractive haven for investors in municipal bonds, with falling yields a sign that the bond market hasn’t given up on the state–yet.

The current issue of the Financial Advisor reports:

The extra yield investors demand to hold debt of California issuers instead of top-rated local-government bonds matched a three-year low on May 15, according to Bloomberg Fair Value data. The day before, Governor Jerry Brown proposed cutting state workers’ pay 5 percent to save money after the state’s spending gap grew 71 percent since January.

Across the U.S., taxpayers are benefiting as the most money in three years floods into muni mutual funds while coupon and principal payments are set to exceed issuance through August….

Investors looking for a haven from Europe’s debt crisis have added about $12 billion to U.S. muni funds this year, the best annual start since 2009, Lipper US Fund Flows data show.

That’s helped keep local-government interest rates close to the lowest since the 1960s, even after they climbed last week. Twenty-year general-obligation bonds yield 3.75 percent after touching 3.6 percent in January, the lowest since 1967, according to a Bond Buyer index….

The extra yield on issues from California, the lowest-rated U.S. state by Standard & Poor’s, fell to 0.82 percentage point last week, matching the smallest since December 2008, according to data compiled by Bloomberg. On May 14, Brown said his state’s deficit had grown to $15.7 billion from $9.2 billion in January.

It is not clear how long California’s good fortune will last–or whether the state’s leaders will muster the political will to make the necessary changes before creditors lose faith.