SAN FRANCISCO — Los Angeles is not California.

Leaders in the nation's second-largest city insisted this week they haven't slipped into the kind of political paralysis that has made it nearly impossible for California to balance its budget and that garnered it the lowest state credit rating in the nation.

"This is the strongest relationship between a council and a mayor that has existed in my lifetime," said City Council President Eric Garcetti. "Not only are we balancing for this year, but we will put in place some really tough decisions to be on track for the next few years as well."

Policymakers' ability to agree on budget fixes is in question because Los Angeles began the fiscal year with a precarious budget — balanced on the assumption that workers would agree to enough pay cuts, early retirements and layoffs to fill a $230 million hole in the $4.4 billion general fund by year-end — and then suffered a deeper-than-expected drop in revenue that is likely to nearly drain the city's reserves this year.

Despite significant labor concessions, the budget shortfall is now forecast to be about $212 million in the current fiscal year and $485 million next year. The city expects to spend its reserves down to about $24 million this year to bridge the gap and hopes to replenish them with $100 million to $200 million gained from privatizing its parking garages.

Slow progress closing the deficit led Fitch Ratings to downgrade Los Angeles' general obligation rating to AA-minus from AA in November, and this week Moody's Investors Service revised its outlook to negative on the city's Aa2-rated GOs, citing political worries.

"The revised outlook primarily reflects the possibility that the city may experience an extended, multi-year period of significantly diminished general fund reserves, limiting its financial flexibility and weakening its balance sheet to a level inconsistent with the current rating," Moody's analyst Eric Hoffmann said in a report Wednesday. "The erosion in the city's historically better-than-average willingness and ability to quickly rebalance its budget mid-year also contributes to this revised outlook."

As Hoffmann's statement suggests, big, politically liberal Los Angeles has a reputation for fiscal restraint, with a history of conservative budgeting and a fairly sparing use of debt. The city came into the recession with general fund reserves of about 10% of spending.

But with double-digit percentage decreases in major revenue streams and little revenue-raising flexibility, the city is rapidly depleting those reserves and faces the unpalatable task of cutting thousands of workers from its payrolls. That's never easy for a city council.

Mayor Antonio Villaraigosa last month proposed 1,000 layoffs to help close the mid-year budget gap. That would bring the number of positions cut this fiscal year — including early retirements already approved — to 3,400 workers. Villaraigosa has warned another 2,000 job cuts may be needed next year.

The City Council approved the latest round of layoffs, but the resolution said they couldn't take place for 30 days. Some council members bemoaned the economic damage that such job cuts could do, insisting there must be a better way.

Local media — as well as The Bond Buyer — reported the council had delayed action on the mounting deficit. Analysts from Fitch and Moody's warned the city that it needed to act immediately to avoid downgrades, according to city finance officials.

"Predictably, this proposal has met with opposition," Hoffmann said. "It is, unfortunately, one of the plan's few immediate, tangible cost-saving elements, and delaying its implementation will, while preserving jobs, potentially weaken the city's long-term credit quality."

Villaraigosa on Feb. 3 issued an executive order telling administrators to move ahead with the job cuts immediately and last week made a rare council appearance to insist on quick action.

Garcetti insisted the council hasn't delayed action "by one day." He said civil service rules mean job cuts take a few months, and the inconsequential 30-day provision allowed him to get unanimous support for the layoffs. He said the council is moving ahead with a "Three-Year Plan to Fiscal Sustainability."

City administrative officer Miguel Santana — one of the authors of the three-year plan and a mayoral appointee — said no further council action is required on this year's layoffs.

"Virtually every recommendation in that report … has been approved by the council," he said. "While there has certainly been a lot of political drama over the last two weeks, if you look at the outcomes, the outcome is that a council majority eliminated 1,000 positions."

The next step is to negotiate a budget for next year and implement the financial plan. The plan calls for consolidation and elimination of city departments; negotiating further reductions in labor costs; privatization of non-core services, including the parking garages and possibly the city zoo, convention center, and golf courses; and borrowing to get through next year. Santana said the plan will return Los Angeles to structural budget balance and replenish a 5% reserve by 2012.

Villaraigosa, Garcetti, and rating analysts all agreed that the most important measure of the city's progress is the reserve balance at the end of the year.

"What I and the majority of this council, and certainly the mayor, want to see is a more robust reserve fund, where, worst case scenario, we're somewhere north of $60 million for the reserve fund balance" before adding in parking privatization proceeds, Garcetti said.

"If the reserve fund ends the year at the $20 million or $30 million level, we haven't done a thing. If we get to the $75 million level, we've done some really tough and strong things."

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