California Won't Go Broke, Says Merrill Analyst

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Fears of an imminent default on debt issued by California may be overstated, according to a Merrill Lynch analysts. The state is unlikely to run out of cash and go broke, Merrill muni strategist Phillip Fischer said in a note on May 11th.

Shifted fiscal allocations and delayed spending will help, as will a patchwork of federal aid, according to Fischer. Bond prices are begining to reflect a renewed confidence, with yields shrinking. Bloomberg has been tracking the extra yield that California must offer bond investors on 10 year bonds, compared with top-rated municipal issuers. The spread has narrowed to 121 basis points from 132 basis points on April 3.

We’d say that the market is probably also pricing in the possibility that Barney Frank will get his way and we’ll have a federal backstop of all muni debt soon enough. Even without a formal backstop, we think it’s unlikely that the Obama administration and a Democrat controlled Capitol Hill would let California default.

This is another way that we’ve broken the signalling function of the credit markets, which no longer provide clear indications of expected economic performance thanks to the numerous and varied government interventions.

 

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