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Brown Wants to Hold Off on Selling California School Bonds

California Gov. Jerry Brown wants the state to hold off on selling the $9 billion of general obligation bonds for school construction the state's voters approved in November.

Brown, as part of the fiscal 2018 budget proposal he released this week, said the bonds should remain unsold until the Legislature establishes better auditing procedures.

Brown released his $179.5 billion spending plan Tuesday.

A 2016 Department of Finance report criticized the Office of Public Construction for not fixing problems uncovered in a review of audits on $7.3 billion in bonds that were authorized by voters in 2006.

The report was a follow-up to a June 2011 review of the Office of Public Construction's procedures.

Half of the six recommendations made by DOF in 2011 have not been implemented, according to the report.

Voters approved Proposition 51, a K-14 school construction bond initiative opposed by the governor, with a 55% majority in November.

A legislative advocate for California Coalition for Adequate School Housing said the organization, a major supporter of the bond measure, supports the governor's efforts.

"We think those things should be audited," said David Walrath, an education lobbyist and president of Murdoch, Walrath & Holmes, Inc. "We just want to work with the administration and get this done as soon as possible."

Walrath thinks the state could establish better procedures by April and have them in place in time for the governor's annual May revision of the budget. If that's the case, lawmakers could consider adding plans for a school bond sale then, he said.

"You will see in the audit that a number of things related to how school bonds were spent do not fall under construction or maintenance of school facilities," said H.D. Palmer, a spokesman for the state Department of Finance. "We indicated in the budget summary that we are going to look at having additional requirements, so that there is proper accountability for bond funds."

The topic is up for discussion at the Jan. 25 meeting of the State Allocation Board with the aim of drafting language for the governor's budget trailer bill due Feb. 1, Palmer said.

As of September 2015, 1,533 projects representing over $3 billion in Proposition 1D bond proceeds had been closed without an audit to determine whether the money was spent in line with the bond measure's requirements, according to the June 2016 report.

DOF conducted a limited audit of 19 Proposition 1D projects at 10 school districts. The limited audit found the districts had inappropriately used $3 million in bond funds to purchase such items as a Chevrolet truck, two tractors, four golf carts, iPads, athletic uniforms, a mascot uniform and custodial/cleaning supplies.

The audit "delineated that inappropriate spending had occurred in the prior bond program," Michael Cohen, director of the state Department of Finance said during the press conference. "We just want to make sure all the money is spent appropriately on the front end and we audit it properly on the back end."

The governor opposed Proposition 51, the school bond measure, contending that the current system is rigged to favor larger, well-heeled school districts over smaller districts that need the help more. But Palmer said the governor accepts that voters have approved the bond measure and it is the law of the state.

The authorizations in the prior bond measure have been depleted. As of December, the state had 165 applications from school districts for new construction and maintenance projects totaling $370 million waiting for funding, according to the Department of Finance.

In general, the state will also continue to manage cash flow with an eye to reducing the need for debt, Cohen said.

"I don't see any need to do any cash flow borrowing this year, because we are still in a better position than we had been for the past 15 years," Cohen said.

The state will hold general obligation bond sales in the spring and fall as it does every year, Cohen said.

"When we got here, there was $10 billion cash-in-hand not ready for program use," Cohen said. "One reason we are selling less bonds than in previous years, is because we only sell bonds when we are ready to go. We expect to continue to sell less bonds than in previous years."

Brown's budget includes $2.4 billion in bond funds. Transportation, natural resources and housing get the largest shares at $881 million, $564 million and $383 million.

The state still gets knocks from rating agencies for its revenue volatility and lack of flexibility around budgeting, but it is a far cry from where it was in the decade before the 2008 recession.

In 2015, the state paid off the last of $15 billion in so-called economic recovery bonds issued in 2004 to cover a $35 billion deficit.

"The last recession was very painful for California. There were significant spending cuts to programs and there had been a lot of borrowing to fund operations," said Moody's analyst Emily Raimes, who is a manager of the states and high-profile ratings team. "Since then, the governor and the legislature have realized it is important to pay back borrowing and get on solid and stable footing to prepare for downturns."

In five of the seven months since the current budget passed, the state has missed revenue projections.

The State Controller's Office announced Tuesday that state revenues for December missed projections by $1.87 billion, coming in 12.7% less than anticipated in the 2016-17 budget.

"I think as the governor mentioned in his budget presentation, the state may be looking at a turning point in revenues," Raimes said. "For a couple of years, state revenues were coming in ahead of forecasts almost every single month. The tide has turned – and there have been many months when revenues came in under forecasts."

California's revenue is very volatile, so small changes in revenue streams can impact state finances, Raimes said.

Brown said the state "has one of the most progressive tax systems in the country, but as a corollary, we have one of the most unreliable revenue systems in the country."

This results in the budget relying more on capital gains than on property tax revenue.

Brown's proposed budget would deposit $1.15 billion in a rainy day fund for a total of $7.9 billion by the end of 2017-18. But Raimes said that putting 10% of tax revenues away may not be enough, given the state's revenue volatility.

States like North Dakota and Alaska that are also subject to wide revenue swings have much larger reserves, proportionally, than California, she said.

Moody's conducted a stress test on the four most populous states in April 2016 that considered their ability to ride out a recession that found California wanting. California was considered by the rating agency to be the least able to weather a recession compared to Texas, New York and Florida.

The study looked at revenue volatility, the amount of reserves the state expected to have at the end of fiscal 2017, whether those reserves could cover a revenue decline on par with the tech crash of 2001, and budget flexibility.

In California's favor, state law changed in 2012 enabling legislators to approve a budget with a simple majority, which ended a decades-long habit of the state not passing a budget on time, Raimes said. But it still needs a two-thirds supermajority to raise taxes or make significant budget changes, she said.

The fact that Democrats have a supermajority is not expected to make much difference.

"If we look back through history, at states that have a lot of dysfunction and those that have operated smoothly, it's not really correlated to which parties have power," Raimes said. "We have also seen a legislature and administration in California that has been in agreement and been able to get a lot done."

Instead of using the supermajority, the state asked voters to approve the extension of what was supposed to be a temporary tax increase on the income of high-net Californians.

Fitch Ratings and S&P also have noted the state's lack of flexibility to change the budget once it is passed.

The governor is banking on the ability to modify his proposed budget in May if revenues come in low or to deal with changes to federal funding from the Trump administration.

Though Brown pointed to the potential harm to the state's financial position if Obamacare is repealed, the budget doesn't take into account any of the potential changes to federal funding.

The budget relies on more than $105 billion in federal funding and repeal of the healthcare act could cost the state $16.1 billion in lost Medicaid reimbursement.

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