As deficit grows, Calif. prepares to issue IOUs

[July 02, 2009]  SACRAMENTO, Calif. (AP) -- California's controller will start paying many of the state's bills with IOUs as soon as Thursday after lawmakers failed to close the state's worsening budget deficit, adding a new measure of indignity to a state sinking deeper into dysfunction.

Lawmakers' failure to act on Tuesday, the end of the fiscal year, also widened California's deficit from what already had been a whopping $24.3 billion -- more than a quarter of its general fund.

The failure to balance the state's main checkbook and the looming IOUs prompted Gov. Arnold Schwarzenegger on Wednesday to declare a fiscal state of emergency.

Under the declaration, state offices will be closed three days a month to conserve cash. If the Legislature fails to solve the deficit within 45 days, it cannot adjourn or act on other bills until the crisis is resolved.

The partial government shutdown also will lead to a third furlough day for 235,000 state employees, bringing their total pay cut this year to about 14 percent.

"California needed the Legislature to act boldly and with conviction. Their response was not a solution to California's budget problem but an invitation to actually a bigger financial crisis," Schwarzenegger told reporters Wednesday.

On Tuesday, as the previous fiscal year was drawing to a close, the Senate rejected three bills designed to save $5 billion, including $3.3 billion in education funding cuts that had to be enacted. Passing those bills would have given the Legislature time to work out a broader solution to the deficit and delayed the need for IOUs.

Instead, the budget shortfall is set to grow even wider because of California's complicated school funding formula, meaning the state will not have enough money to pay all its bills.

State Controller John Chiang said his office is prepared to issue IOUs totaling $3.3 billion in July.

Senate Minority Leader Dennis Hollingsworth said neither he nor his Republican colleagues wanted to see California resort to IOUs to pay its bills, but he said Democrats had refused to make sufficient spending cuts to solve the shortfall.

"It's unfortunate that we're at this point," said Hollingsworth, a Republican.

It will be the first time since 1992 that California will have issued IOUs. The move is almost certain to further damage the state's credit rating, already the lowest of any state, saddling taxpayers with billions of dollars in higher interest payments on bonds that have yet to be sold.

Issuing IOUs -- formally referred to as individual registered warrants -- also will have real-world consequences for those on the receiving end. Small businesses that rely on state contracts will be most affected.

"It really doesn't affect the million-dollar companies. It's the smaller ones that will get hit," said Paul Nguyen, director of Care Now Staffing, a Southern California company that employs a dozen medical professionals.

The IOUs also will be sent to California counties, which now must find other ways to fund a wide array of social programs, ranging from alcohol abuse and mental health treatment to services for the elderly and disabled. California's universities were evaluating ways to assist students whose grants will not be funded to pay education expenses.

It was unclear whether some of California's largest banks will accept the state's IOUs as payment. They would be paid back, with interest, but the state's precarious financial condition and legislative gridlock might be making some bankers nervous.

Bank of America announced Wednesday it would cash the IOUs for its customers through July 10, bank spokeswoman Colleen Haggerty said. Schwarzenegger and state officials asked other banks to do the same, noting that California has never defaulted.

"We will make those payments," he said. "We are responsible."

[Associated Press; By SAMANTHA YOUNG]

Associated Press writers Judy Lin, Juliet Williams and Jared Grigsby contributed to this report.

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