Maybe it’s because their headquarters are on Montgomery Street in San Francisco instead of Wall Street in New York, but Charles Schwab Co. is telling investors that California is not about to go out of business.

In a rhetorical question-and-answer missive to investors, Schwab income planning director Rob Williams, says “California has severe financial problems, but we think it’s unlikely that the state will default on its general obligation (GO) bonds.”

Then he lists five reasons for reaching that conclusion, including constitutional guarantees; the fact the state can’t file for bankruptcy, and the fact that “states can’t just disappear.”

So does the firm see the state’s current travails as “a buying opportunity?” “No one can say for certain,” says Williams.

Here’s the document.  As Williams says, general obligation bonds are guaranteed by the state constitution, and only education is ahead of paying off these bonds.  Here’s a sample:

Many analysts point out that the state’s revenues are collapsing, its spending is out of control, and the structure of government prevents the state from ever being fiscally stable. Are these concerns valid?

All of these statements may be true, depending on your political view. But these troubles don’t inevitably translate into default on California GO bonds, for all of the reasons cited above.

However, they do translate into serious concerns for other parties interested in the state’s solvency-of which there are many. The politics of the situation can also be noisy, leading to steady reporting of the budget drama and ebbs and flows in market sentiment, likely adding to uncertainty and reducing confidence among investors. As confidence drops, the prices of outstanding bonds drop, and yields rise.

The situation has also resulted in changes to the state’s bond rating, including a downgrade by Fitch Ratings to BBB on July 6 and Moody’s to Baa1 on July 15. These ratings are two and three notches, respectively, from “junk” bond status. The rating is also on negative “Rating Watch,” meaning that the rating will remain on review for additional downgrades “if institutional gridlock” persists.

While ratings alone should not drive an individual investment decision, comments in Fitch’s rating report are worth quoting: “The BBB rating indicates that expectations of default risk remain low, although the rating is well below that of most other tax-supported issuers. GO debt in California has a constitutional prior claim on revenues, although after education.”

In other words, diving into Fitch’s rating report, they essentially admit that their rating is bullshit.  They are dropping the ratings because of perceptions of crisis that don’t match constitutional obligations.  This is gouging.  It’s almost the textbook definition of it.

And if you don’t think that goes on, check out this investigative report from last November:

Goldman, Sachs & Co. urged some of its big clients to place investment bets against California bonds this year despite having collected millions of dollars in fees to help the state sell some of those same bonds.

The giant investment firm did not inform the office of California Treasurer Bill Lockyer that it was proposing a way for investment clients to profit from California’s deepening financial misery. In Sacramento, officials said they were concerned that Goldman’s strategy could raise the interest rate the state would have to pay to borrow money, thus harming taxpayers.

“It could exaggerate people’s worries about our credit,” said Paul Rosenstiel, head of the public finance division of the treasurer’s office.

That’s exactly what’s happening.  The big banks are sparking irrational worry over California’s ability to repay bonds to increase their yields.  The federal government needs to step in with a backstop, not just to save the state money, but to prevent the commission of a crime.

Fitch, one of the main credit rating agencies, fresh off downgrading California bonds from A to A-minus a little over a week ago, just took them another step down today.

The downgrade to ‘BBB’ is based on the state’s continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis. Since no agreement was reached by the June 30, 2009 fiscal year (FY) end, the state’s controller has now begun issuing registered warrants (IOUs) for certain non-priority payments to preserve cash, and the budget gap to be addressed has increased to $26.3 billion from $24.3 billion. The use of IOUs for non-priority payments would offset cash shortfalls into September 2009 as now currently projected […]

With issuance of IOUs for non-priority payments, margins for meeting constitutional and court-required contractual commitments are narrowing. After September 2009, absent any proposed budget and payment adjustments, cash deficits will expand dramatically. Cash flow solutions, including the ability to access short-term borrowing, are inextricably tied to reaching timely agreement on effective and credible budget solutions.

The inability of the state to reach agreement has prompted the controller to begin issuing IOUs for non-priority payments, primarily disbursements to vendors, for certain social services, and for tax refunds, in order to ensure payment of priority payments, including General Obligation and lease debt service. The controller’s office estimates that $3 billion in IOUs will be issued during July 2009; priority payments of $10.8 billion will be made for education, debt service, Medicaid, payroll, pensions and other mandatory contractual obligations. Projections will be revised to reflect June revenue performance and other changes but as currently estimated, cumulative cash deficits of $3.7 billion are projected through August, offset by $4.5 billion in non-priority payments that could be covered with IOUS, excluding tax refunds. However, by the end of October, the projected cash deficit expands to $16.1 billion, well beyond non-priority spending of only $10.6 billion, excluding tax refunds.

It’s true that the IOUs work only until October.  But the credit rating is specifically tied to, in this case, long-term bonds.  And as I’ve laid out previously, as a matter of law debt service has pride of place in the state Constitution – only education must be funded before it.  It would take something like $50 billion dollars in program cuts before creditors must be paid, which is far less than current debt obligations.

In other words, this is a gouging effort by Wall Street, and the credit ratings agencies are downgrading California simply because they can.  The fact that every single creditor will get paid in full if California has to close every hospital and prison in order to do it is of little consequence.  This is all further reason why the federal government ought to provide loan guarantees to stop the gouging from Wall Street.