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Thursday, January 4, 2001 Effect of State's Energy Crisis on Economy May Have Worried Fed

By JAMES FLANIGAN, Times Senior Economics Editor

The California energy debacle is rapidly growing into a financial crisis that could trigger bank failures, disrupt funds available for lending to businesses and consumers and spark general chaos in global markets for corporate bonds, financial experts fear. Such fears may well have been a factor in prompting the Federal Reserve to dramatically lower interest rates Wednesday, analysts suggested. The energy crisis poses a spreading threat to the whole banking system, given that the crisis is occurring against a backdrop of a sharply slowing economy and fears that more corporations may default on their debts, analysts said. A lowering of interest rates doesn't solve the energy problem, but it would ease the plight of California's embattled utilities by reducing their borrowing costs. That in turn would reduce pressure on banks and other participants in global markets that provide credit to those utilities as well as other businesses.

Also, whether intentional or not, the Fed action in effect sends a signal to financial markets that the central bank will support attempts by California's utilities and political leaders to work out a solution to the companies' credit problems, analysts said. But though Fed action inspired a rise in the general stock market, initial action by the California Public Utilities Commission had the opposite effect Wednesday on the state's major utilities, Southern California Edison and Pacific Gas & Electric. The PUC staff issued an initial ruling giving the utilities a temporary 7% rate hike to alleviate their problem of uncollectable costs and rising borrowings. Financial markets evidently saw that as too little, and investors send stocks of both companies into steep declines. To be sure, the Fed's lowering of interest rates was prompted by many factors related to the slowing of the economy. But several experts suggested that California's crisis was a factor, noting that Fed Chairman Alan Greenspan held a highly unusual public meeting in Washington on Dec. 27 with Gov. Gray Davis to discuss the California energy situation. Davis also met with President Clinton during the same trip. Until recently, the plight of Edison and PG&E to finance purchases of electricity at higher prices than they could charge their customers was thought of as an energy problem largely confined to California. But as the utilities' borrowings from banks and in corporate money markets have mounted, to an estimated total of more than $10 billion, the dangers of defaults, bankruptcies and withdrawals of credit have escalated.

As such, the California energy crisis draws parallels to the Russian currency crisis of 1998. Fears that a Russian financial collapse could trigger a global financial crisis prompted the Fed to lower rates suddenly that year, just as it did Wednesday. The problems of Edison and PG&E have multiplied as costs have risen for the electricity the utilities must purchase from generating companies. The utilities cannot pass on such costs to consumers because of a rate freeze dating to California's electricity deregulation in 1998. The utilities' loans from banks and financial markets have grown to such an extent that credit-rating agencies such as Moody's and Standard & Poor's are threatening to downgrade their credit ratings. "It will be hard to refinance those loans," given the utilities' worsening credit situation, said Joan Payden, president of Payden & Rygel, a Los Angeles investment firm. "If their debts are downgraded, we could have illiquidity in the markets."

The companies face the prospect of seeking protection from creditors under Chapter 11 of the Bankruptcy Code, which allows firms to operate under court supervision while terms are worked out with creditors. If the debts of Edison and PG&E were downgraded to a category of less than investment grade--equivalent to "junk" bonds--the consequences for the financial system would be severe, as would the consequences of bankruptcy. Many pension funds and other investing institutions could no longer hold the utilities' bonds if they were not investment grade. The sums involved are enormous. Like all utilities, Edison and PG&E must borrow heavily to purchase and maintain equipment for providing electricity. The total of the two firms' long-term bonds is more than $20 billion, all held by pension funds and institutions worldwide. If such institutions were forced to sell those bonds, the result would be major disruptions in financial markets.

If the utilities were forced into bankruptcy, the effect would be devastating on banks, including giants such as Bank of America as well as smaller banks, and on the commercial paper markets, where companies borrow and lend to each other, said William Gross, chief bond manager for Pacific Investment Management Co., a Newport Beach firm. This could lead to some bank failures and other problems in the banking system, analysts said. At the very least, loans to small businesses and mortgages for consumers would be reduced. The specter of such trouble was a major factor leading the Fed to lower rates Wednesday, said economist William Rhodes of Williams Capital, a New York-based investment bank.

Since the Fed's open market committee last met Dec. 19 and declined to lower interest rates, there have been several continuing indicators of worsening trouble in the economy. Notably, consumer confidence was reported to be falling in the latest study from the Conference Board on Friday, manufacturing slowed sharply, and the debt problems of California's utilities have mounted. The Fed's action sends a powerful signal of support, but a lot still hinges on action by the state's PUC.

The PUC issues a final ruling today on the rise in electricity rates it will allow Edison and PG&E, so they may recover some of their short-term under-collections on electricity purchases. Standard & Poor's and Moody's have said they are watching the PUC decision closely to determine whether they will downgrade the utilities' debts.

But prospects are not hopeful. The PUC staff's initial ruling Wednesday was for a lower rate increase than financial markets were looking for, said security analyst Brian Youngberg of Edward Jones & Co., a St. Louis-based brokerage firm. Edison stock fell 18% and PG&E stock fell 13% after the PUC initial ruling was announced.

Copyright 2000 Los Angeles Times

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-- Martin Thompson (mthom1927@aol.com), January 04, 2001