California Has A Historic Opportunity To Reduce Its Debt ... And It Looks Like It's Going To Blow It

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California is projected to have its first budget surplus in years by 2014.

It has so much money, in fact, that it doesn't know what to do with it.

But now it's already on the verge of blowing this rare window of fiscal stability, according to S&P analysts Gabriel Petek and David Hitchcock.

In a new note, they warn the state for going against Gov. Jerry Brown's recommendation to retire debt and choosing instead to restart funding.

Standard & Poor's Ratings Services believes the higher-than-expected cash receipts presented the state an opportunity to accelerate its plans for retiring the $26.9 billion in budget liabilities that remain leftover from prior years' deficits. Compared with what the governor recommended in May, however, the final budget agreement moves in the other direction, decelerating somewhat the repayment of a portion of these debts.

They say the state has exchanged a $650 million deferral repayment for a $500 million one-time spending measure, along with $150 million in new ongoing education spending.  

"Although the repayment shift is relatively modest in our view, and the [department of finance] still forecasts retiring all of the education deferrals by the end of fiscal 2016, we believe it could set a precedent for similar delays in the future," they write.

The pair note this was made possible in part by a Sacramento quirk: The legislature gets to negotiate the revenue estimates used in the budget:

Whereas more than half the states have independent revenue estimating bodies, California allows political negotiations to influence the revenue number assumed in the budget. As the recently concluded cycle demonstrates, the revenue estimates themselves have sometimes become subject to negotiations in California.

They conclude by bemoaning the state's weak flesh:

With limited resources, we believe the presence of the budget liabilities impedes the state from making meaningful progress on its longer-term liabilities, particularly its retiree health care and teachers' pension liabilities.

But by enacting even small new ongoing spending commitments this year -- which could increase future year expenses -- we detect a softening of resolve when it comes to paying down the internal debts.

There is also a potential cascade effect. We believe that by opening the door to new programs while waiting for future (uncertain) revenue to repay some internal debts, the state delays, or jeopardizes altogether, its ability to confront the long-term liabilities.

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