Bubble Watch: California gets its 1st credit-ratings upgrade in 3 years

“Bubble Watch” digs into trends that may indicate economic and/or housing market troubles ahead.

Buzz:  For the first time in three years, a major Wall Street debt-grading agency has upgraded California’s credit rating.

Source:  Fitch Ratings

The Trend

Citing improved financial habits of the state government, Fitch upped California’s grade to “AA” from “AA-minus“ — a level that is still below average for U.S. states. Fitch last upgraded California in August 2016. This is California’s fourth straight upgrade since the Great Recession from Fitch and while grading criteria have evolved over time, the last time California was AA was 2002.

The Dissection

Credit ratings are an odd slice of Wall Street mechanics that technically relates to what an institution — government or corporate — pays to borrow. These grades are by no means perfect measurements of risk but the reality is these ratings are often seen as one yardstick — historical or against peers — of fiscal fitness.

Fitch analyst Karen Krop says this isn’t simply about a powerful statewide economic recovery that, among other things, helped create a huge government budget surplus. She said California gets higher marks for its consistent trend of retooling its fiscal activities to make the state government less vulnerable to future economic downturns.

Due to these efforts, Krop says California’s government finances are far better prepared for a potential recession than it was before the last economic collapse. Everything from temporary tax increases to limits on spending growth — neither very politically popular actions — have been key.

“They really righted the ship,” she said. “They got just about everything back to where it ought to be.”

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California joins Alaska, Hawaii, Maine, Michigan, Oklahoma, Rhode Island and West Virginia in the “AA” club. But 35 states have better grades.

And no discussion about California’s finances can ignore the state’s government workers’ large, underfunded pension obligations. And Kopp explains that pension-cost challenges are slow-moving burdens. “You would never see it as a falling off cliff,” she said.

California’s government has taken significant steps to improve the financial stability of its huge pension funds, noted Krop. As credit graders, though, she noted Fitch doesn’t weigh the grand political debate of how to fund these liabilities— are pensions too generous vs. the cost of higher taxes or less other services to pay for the benefits.

But Krop notes that California is by no means alone with the pension challenges, adding the pension risks to the state’s fiscal health, compared to other states, can be seen as “moderate.”

Other views

The two other big credit grades — Standard and Poor’s and Moody’s — latest upgraded the state in 2015 and 2014, respectively.

How bubbly?

On a scale of zero bubbles (no bubble here) to five bubbles (five-alarm warning) … ONE BUBBLE!

State government is a big slice of the economy. So perhaps this upgrade might slightly calm the fears of folks who think the state’s going broke — or will financially collapse during the next downturn.

Remember, too, this is not a pristine scorecard. Only six states have lower grades. Hopefully, the shortcomings are noted by the folks in charge.

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