EconomicsJunkie

A hidden message from the governor:

California Governor Arnold Schwarzenegger is ticked off.

He’s tired of signing bills that don’t address the pet causes he deems important. So when another unworthy bill crossed his desk recently for signing — addressing funding issues for the Port of San Francisco — the guv vetoed it and sent lawmakers a little note saying why. Only the note said a little more than lawmakers were expecting.

Buried in the text was a hidden message directed at State Assemblyman Tom Ammiano, author of the bill, according to the San Francisco Bay Guardian.

Ammiano had strongly criticized the governor in early October and reportedly told Schwarzenegger at the time to “kiss my gay ass.” Schwarzenegger’s veto letter, issued a couple of days later, reads:

Missed the hidden code? The Bay Guardian has helpfully picked it out:

When asked by the Guardian if the message was intentional, Schwarzenegger’s spokesman said only, “what a strange coincidence.” The paper noted that he was “clearly being sarcastic.”

… water reform, prison reform, and health care are indeed the major issues that California representatives should be dealing with before even considering for a second any more hideous spending programs with no end in sight.

I understand the Governor’s frustration and do realize that this message is obviously and intentional note of frustration and rebuke.

I expected this to happen, California Won’t Accept Its Own IOUs:

Small businesses that received $682 million in IOUs from the state say California expects them to pay taxes on the worthless scraps of paper, but refuses to accept its own IOUs to pay debts or taxes. The vendors’ federal class action claims the state is trying to balance its budget on their backs.

Lead plaintiff Nancy Baird filled her contract with California to provide embroidered polo shirts to a youth camp run by the National Guard, but never was paid the $27,000 she was owed. She says California “paid” her with an IOU that two banks refused to accept – yet she had to pay California sales tax on the so-called “sale” of the uniforms.

The class consists mostly of small business owners, many of whom rely on income from government contracts to keep afloat. They say California has used them as “suckers” as it looks for a way to bankroll its operations while avoiding its own financial obligations.

“Instead of seeking funds through proper channels, the State has created a nightmare,” the class says. “Many of these businesses will not survive if they are required to wait until October 2009 to have these forced IOUs redeemed by the State.”

The class claims the state is violating the Fifth and Fourteenth Amendments. It demands that California be ordered to honor its own IOUs, plus interest. They are represented by William Audet.

…time to flood the FTB with IOUs. Let them issue a public explanation as to why they do not want to accept the state’s own IOUs.

Governor Schwarzenegger used the line item veto to slash the bloated California budget by another $500 million:

Gov. Arnold Schwarzenegger on Tuesday signed a budget plan sent to him by lawmakers to close the state’s monumental deficit, using his veto pen to impose nearly $500 million in additional cuts.

The new reductions will affect child welfare and children’s healthcare, the elderly, state parks and AIDS treatment and prevention, going beyond the dramatic cuts that were part of the deal Schwarzenegger negotiated with legislative leaders.

Democratic leaders in the Assembly and Senate reacted angrily to his use of the line-item veto, disputing the Republican governor’s authority to wield that power in this situation and portraying him as callous.

Schwarzenegger’s aides said the cuts were proper, and the governor said they were necessary.

“This has been a very tough budget, probably the toughest since I have been in office here in Sacramento,” Schwarzenegger said. “This budget is kind of like the good, the bad and the ugly.”

The good, the governor said, is that the plan does not raise taxes and includes changes he says will make government more efficient, such as reorganizing and abolishing some boards and commissions.

The bad are the deep cuts to state programs that will touch millions of Californians, particularly its most vulnerable citizens, he said.

The ugly, Schwarzenegger added, are the new reductions he made because lawmakers left town after failing to fully close the state’s deficit.

The Assembly on Friday capped a 20-hour session by rejecting provisions worth $1.1 billion that had been agreed to by the governor and legislative leaders.

The extra cuts the governor made Tuesday — $489 million — took nearly $80 million that pays for workers who help abused and neglected children; $50 million from Healthy Families, which provides healthcare to children in low-income families; $50 million from services for developmentally delayed children under age 3; $16 million from domestic-violence programs; and $6.3 million from services for the elderly. Among other reductions was $6.2 million more from parks, which could result in the closure of 100, rather than 50, of California’s 279 state parks.

In addition, Schwarzenegger effectively gutted a program that provides local governments with funding to encourage property owners to preserve open space and to use land for agriculture.

Ted Lempert, president of Children Now, an advocacy group, called the cut to Healthy Families “particularly galling.” He said a coalition, including his group, is spearheading a campaign to put a universal children’s healthcare measure on the fall 2010 ballot.

“A struggling family puts their kids first,” Lempert said. “What the governor and what the state has done is the opposite.”

Assembly Speaker Karen Bass (D-Los Angeles) and Senate leader Darrell Steinberg (D-Sacramento), in questioning the legality of Schwarzenegger’s moves, suggested that the governor’s veto power can be used only on original appropriations. The new spending plan is a revision of a budget Schwarzenegger and lawmakers ratified in February.

Both leaders said they would attempt to restore the cuts when they return from recess, in mid-August, and Bass said she would seek an opinion from the Legislature’s legal office.

In a long and harsh statement to the media, Bass called the governor “so eager to tear down the safety net that he appears willing to break the law to do it.” She faulted Schwarzenegger for rejecting taxes that Democrats proposed on “big oil and big tobacco” and instead attacking “the sick, the young, the elderly and battered women.”

In response, Schwarzenegger’s aides said Bass and the Assembly had forced his hand.

“The governor understands how difficult these cuts are,” said his spokesman, Aaron McLear. “But because the speaker sent him an unbalanced budget, he had no choice but to make these cuts.”

Assembly lawmakers turned down a plan to seize $1 billion in gas tax money that belongs to local governments and rejected a new offshore oil drilling project that could have produced $100 million in royalties.

The Senate approved the entire budget deal, including those measures, early Friday morning.

By killing the two proposals, lawmakers wiped out a reserve fund the governor has insisted upon to cushion future shortfalls. His aides said the cuts announced Tuesday would allow the state to put aside $500 million.

Even as he signed the plan, Schwarzenegger warned that the state’s troubles were not over. Finance officials are already predicting future deficits, and the governor said he was ready, “if our revenues drop further, to make the necessary cuts and live within our means.”

Overall, the new budget is expected to fundamentally alter life for many Californians, with reductions to K-12 education, state colleges and universities, healthcare and public assistance for the elderly and the poor.

It appropriates billions of dollars from local governments, which could force cities and counties to further reduce their own spending on roads, law enforcement and other services.

The package was approved to address a deficit that administration officials previously projected at $26.3 billion. Schwarzenegger’s aides now say that, although the budget plan contains $24 billion in solutions, it will close the entire shortfall because of changing revenue forecasts, a recalibration of education funding formulas and a decision to reduce the reserve fund.

The plan’s cuts, accounting maneuvers and other measures should soon enable California to resume paying all of its bills again. From July 2 until the end of the day Monday, the state had issued 209,219 IOUs worth $1.09 billion, according to Garin Casaleggio of the state controller’s office.

The state’s credit rating has declined to nearly junk status after two months during which elected officials could not agree on how to resolve the crisis.

I agree that the budget is a lot like the good, the bad, and the ugly. But in a different way:

The good: No more taxes for now.
The bad: No tax cuts.
The ugly: The tax hikes that will follow sooner or later if the budget is not slashed further.

California hotel foreclosures have jumped up by more than 100% in the past 2 months:

From Watch List reader, Alan X. Reay, founder and president of Atlas Hospitality Group in Irvine, CA, comes this astounding statistic. The number of California hotels in default or foreclosed on has jumped 125% in the last 60 days. The state now has 31 hotels that have been foreclosed on and 175 in default.

With 19.6% of the total, San Bernardino County leads the state in foreclosed hotels. Riverside County follows with 16.1% and San Diego County has 12.9%. Los Angeles County, with 12% of the total, has the most hotels in default. San Bernardino County is next with 9.7% and San Diego County follows with 8%, according to Atlas Hospitality.

“Initially, the wave of distress in California was seen by the smaller, non-flagged hotels in secondary and tertiary markets,” Reay said. “As the hotel economy worsened, we have seen it impact all property types. The properties range from the luxurious St. Regis Monarch Beach Resort (pictured) in Dana Point to the more economical Extended Stay and Red Roof Inn chains. No market or brand is immune in this downturn.”

Non?franchised hotels account for a disproportionate number of foreclosures. They make up about 87% of the total. However, franchised hotels make up 59% of the defaulted properties.

“In reviewing the hotels in default or foreclosed on, we found that over 75% of the loans originated from 2005 to 2007. During this period, over 2,500 California hotels either refinanced or obtained new purchase loan financing,” Reay added. “Unfortunately, based on today’s market values, we estimate that none of these hotels have any equity remaining. The unprecedented decline in room revenues (California is down 21.5% year-to-date) combined with the jump in cap rates has resulted in a massive loss in values. We estimate that values are currently 50 to 80% lower than at the market’s peak in 2006-2007.”

This is a wave that is only just beginning to unravel. Commercial property crunchtime, along with the end of comsumerism, will render many hotels useless and leave their owners with mountains of debt with no equity to cover it.

I agree with the Wall Street Journal’s assessment of the current California budget solution, California Budget Woes to Persist:

State lawmakers on Thursday evening were preparing to vote on a proposal to close a $26 billion budget deficit, but the plan likely will be a stopgap that passes the state’s financial woes on to the next year and the next governor.

The state will probably amass an additional shortfall of as much as $10 billion during this fiscal year, economists say, calling revenue projections for the proposed budget too optimistic. And the financial woes will likely persist for at least the next several years. Though lawmakers are cutting $16 billion in spending, they are closing the remaining $10 billion gap with borrowing, accounting gimmicks and asset sales that will be impossible or difficult to replicate in the future.

“The state has just once again failed to address its underlying problem,” said Bill Watkins, executive director of the California Lutheran University’s Center for Economic Research and Forecasting. “They do some of the hard choices they have to, and they essentially have to pass on part of the problem for later.”

The budget mess is already taking center stage in the race to succeed Gov. Arnold Schwarzenegger, who must leave office after the November 2010 election because of term limits. “It’s the issue that transcends all other issues,” San Francisco Mayor Gavin Newsom, a Democratic candidate, said in an interview Thursday. “You can’t talk about issues in health care, education and infrastructure improvement until you focus on the issue of these structural imbalances in the budget.” Mr. Newsom blasted the spending plan for taking $4.7 billion from local governments, saying the governor should have been open to new taxes on tobacco and oil extraction instead.

My comment: If you are thinking about voting for Gavin Newsom for next governor, think again. Keep this statement of his in mind. He may be personable and nice, I know that … he’s my mayor. But he has it exactly backwards. He is seriously considering to continue raising taxes on Californians.

Republican contenders such as Meg Whitman, the former eBay Inc. chief executive, condemned the budget as well. “As painful flaws begin to appear in this agreement, Californians should demand strong leadership focused on job growth, fiscal restraint and the effective management of our state,” she said in a statement earlier this week. Through a representative, Ms. Whitman declined to be interviewed.

Steve Poizner, a Republican gubernatorial candidate and the state’s elected insurance commissioner, said he gives the budget compromise a C-minus because it contains too few overhauls and pushes the fiscal problems to future years. “We’re going to go from one budget issue to another until we get a couple of basic reforms that are going to turn the state around,” he said. “I’m advocating modernization and overhaul.”

Former U.S. Rep. Tom Campbell, a Republican candidate who has served as the state’s finance director, didn’t return calls for comment.

Even California legislative leaders who negotiated the budget pact acknowledge they will probably have to revisit the spending plan by January to close a new shortfall.

They already are spoiling for another fight along party lines over taxes and spending cuts. “My clear message after tonight is that we have cut enough,” said Senate President Darrell Steinberg, a Democrat. “When you see people writing about the California dream and is it still real, I think that is a reflection of very common feelings that public services, education, transportation, public safety matter to the quality of life in California.”

My comment: Ah yes, those good old values that made California the great state it once was. The values that made innovative entrepreneurs and pilgrims come here to start a new life, dreaming of government service, paying taxes, teaching, train dispatchers, and policework. – The extent to which these state legislators are out of touch is truly staggering.

Republicans, meanwhile, vow to fight new taxes. Almost every GOP state legislator has signed an antitax pledge, though six of them in February broke party lines to approve a plan to close a then-$42 billion shortfall through tax increases and deep cuts. Minority Republicans can hold up budget deals because California requires a two-thirds vote to pass spending plans.

Legislative leaders, who negotiated the budget deal with the governor, have defended the use of one-time fixes in the current budget. Mr. Steinberg said the temporary solutions come in lieu of more spending cuts that would have hurt the poorest Californians. Assembly Minority Leader Sam Blakeslee said the state’s revenue drop amid the recession is historically large, and the fixes are meant to keep California afloat until better times.

Economic forecasters still aren’t sure when that will be. Mr.Watkins said his forecast shows the state won’t show signs of economic growth until early 2011. That’s much more pessimistic than the projection used for the current budget pact. “They’re using old data,” Mr. Watkins said of state finance officials, “and so the revenues will disappoint.”

… which will ensure that the California budget saga is bound to continue.

The LA Times writes California’s biggest government pension funds lose almost $100 billion:

With a state budget agreement at hand, look for Gov. Arnold Schwarzenegger to tackle the state’s troubled retirement system.

On Tuesday, the country’s two biggest public pension funds reported losing almost $100 billion in the fiscal year that ended June 30. And the governor is expected to highlight the new numbers as he renews a campaign to trim the cost of providing lifetime, fixed benefits to hundreds of thousands of government retirees.

“No long-term fix is more important to our state’s solvency,” Schwarzenegger wrote in an opinion column in The Times this month. The governor plans to ask the Legislature to approve changes in the system.

The state, he said, would save money by giving smaller pensions to new state workers through changing “our unsustainable retiree pension formulas.”

The governor’s push for a pension overhaul took on a new urgency when the California Public Employees’ Retirement System and a sister agency, the California State Teachers’ Retirement System, separately announced that they’d lost about a quarter of the value of their investment portfolios. CalPERS’ preliminary losses were $56.2 billion, while the teachers’ retirement system lost $43.4 billion.

Schwarzenegger told reporters last week that the big pension funds could face an estimated $300-billion shortfall in covering the cost of pensions to current and future retirees.

The financial hemorrhaging underscores the risk to taxpayers of ensuring generous fixed benefits to retired government workers, said Marcia Fritz, vice president of the California Foundation for Fiscal Responsibility, which seeks to revamp the pension system.

“It’s crazy to put so much of our resources into such a generous retirement,” said Fritz, a certified public accountant in the Sacramento suburbs.

The tremendous drop in the portfolios’ value is expected to have a direct effect on the amount of money that the state and about 2,000 local governments and school districts must contribute in coming years to pay for pensions for more than 1.6 million government workers, retirees and their families.

As income from the pension investments falls, the governments would have to make up the difference to meet the state’s pension obligations to workers and retirees. CalPERS expects to hike government contributions for the state in 2010 and for local governments in 2011.

According to CalPERS actuaries, it must earn an average of 7.75% annually to avoid such annual increases. That target is reachable over time, CalPERS said in a statement Tuesday, noting that its “long-term 20-year investment return remained positive at 7.75%” despite the current global economic crisis.

The most recent losses were not a surprise, CalPERS Chief Investment Officer Joseph Dear said Tuesday.

“The system has more than enough cash through contributions and income from investments to meet our present liabilities, so we are in a good position to ride out the current downturn and come out stronger,” Dear said.

CalPERS has modified its investment mix and risk-management policies in an effort to boost earnings, Dear said. The pension fund, he noted, already has rebounded by $20 billion since dipping to a recent low of $160 million in March.

As of June 30, 2008, CalPERS’ holdings in stocks, private equity, real estate and commodities positions were worth $239.2 billion. The value fell to $180.9 billion by the end of last month, according to preliminary results.

CalPERS hit a record-high balance of $247.7 billion two years ago after earning double-digit returns for the five fiscal years that ended June 30, 2007.

To ease the damage on cash-strapped cities and counties, CalPERS’ board has approved a plan that would spread the latest fiscal year’s deep losses over the next 30 years, beginning in mid-2011.

The teachers’ fund, which provides retirement benefits for 833,000 public school educators and their families, reported investments worth $118.8 billion on June 30, down 25% from $162.2 billion a year earlier.

It suffered severe losses across its portfolio, which was hit hard by a 43% decline in its real estate values, a 28.2% drop in the value of its stock holdings and a 27.6% loss in private equity holdings.

Investment earnings over time won’t be enough to meet all the fund’s obligations to retirees, Chief Executive Jack Ehnes said.

“We are not in a crisis to resolve the contribution gap,” he said. “But the sooner a solution is found, the lower the cost.”

Schwarzenegger is on the right track. This pension system is completely unsustainable. Benefits will have to be restructured and slashed. Otherwise they are bound to collapse.

At long last, California reaches budget deal:

California Governor Arnold Schwarzenegger and top lawmakers agreed Monday to close a $26.3 billion deficit in the state’s budget in a deal that includes $15.5 billion in spending cuts, they said.

The government of the most populous U.S. state, also the world’s eighth-largest economy, began its fiscal year on July 1 facing the massive shortfall due to a plunge in revenues caused by the recession and rising unemployment.

Schwarzenegger, a Republican, said during a news conference the budget would be balanced through deep spending cuts and borrowing and shifting of state funds but without raising taxes.

“All around I think it is a really great, great accomplishment,” said the former Hollywood action star, noting the closing rounds of budget talks, which dragged on for weeks, had been like a suspense movie.

The Legislature’s top Democrats and Republicans said they would brief rank-and-file lawmakers on the agreement in the hope of holding votes in the Democratic-controlled state Assembly and Senate Thursday.

Democratic leaders acknowledged the agreement contained painful spending cuts in popular programs, the result of mounting financial woes for the state’s government since 2007.

Public schools, colleges and universities would lose $9 billion in funding, prisons more than $1 billion and cities and counties roughly $4 billion. Many state employees would have to take three furlough days each month through June 2010, which amounts to a roughly 14 percent pay cut.

“There isn’t a whole lot of good news in this budget,” said Senate President Darrell Steinberg.

Well, the good news is the $15.5 billion in spending cuts. The bad news is that taxpayers will be on the hook for yet another $10.8 billion. Those should also have been financed by cutting spending. And in fact, California needs to cut a whole lot more spending beyond that, remove bureaucracies, cut the crushing tax burden, phase out unsustainable pension plans, etc…

This will be a temporary fix for now, California will be running out of cash again sooner or later, and once that becomes evident, the bureaucrats will be back at the table to discuss how to cover the next shortfall.

As California legislators continue to drag their feet, and As California struggles, Fitch cuts debt rating:

SAN FRANCISCO (Reuters) – California suffered a new setback in its financial crisis on Monday when Fitch Ratings cut its rating on the state’s general obligation debt to just two notches above junk status.

Fitch cut its rating on California’s long-term bonds to “BBB,” two notches above speculative grade, citing the state’s budget and revenue crisis.

The state last week started issuing “IOU” promissory notes for some bills to conserve cash for priority payments, including payments to investors holding the state’s debt.

The rating agency also kept the debt of the most populous U.S. state on watch for additional downgrades. California ranks as the lowest-rated state general obligation credit by Fitch, followed by Louisiana, at “A+.”

Tom Dresslar, a spokesman for State Treasurer Bill Lockyer, said the other two main credit rating agencies, Standard & Poor’s and Moody’s Investors Service, could soon follow Fitch’s example. “I’m sure their patience is not deep,” he said.

Lower ratings could raise California’s borrowing costs during a severe cash crunch in Sacramento, the state capital, where talks between Governor Arnold Schwarzenegger and lawmakers to plug a $26.3 billion budget deficit for the fiscal year that began on July 1 are plodding along.

“If we’re forced to pay tens of millions of dollars, if not hundreds of millions of dollars, in higher interest costs because we have a delayed budget, that’s tantamount to lighting money on fire,” said H.D. Palmer, a spokesman for the state’s Department of Finance. “That’s money that we could be spending on things like health care or education.”

Standard & Poor’s has California’s general obligation bonds rated “A” with CreditWatch with negative implications. Moody’s has warned of a possible “multi-notch” downgrade in its “A2,” sixth-highest investment grade credit rating of California’s general obligation debt.

In a statement, Fitch said it cut its “A-” rating due to the state’s “inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis.”

FITCH EYES CALIFORNIA’S CASH

Schwarzenegger seized on the Fitch downgrade to criticize state Assembly Speaker Karen Bass for not meeting for budget talks earlier in the day.

“This underscores the urgency to solve our entire deficit,” he said in a statement. “This is not the time for boycotting budget meetings — all sides must come to the table and balance the budget immediately.”

Bass told reporters it was Schwarzenegger who was holding up budget talks by pushing to include overhauls of state government in negotiations: “The issue of reforms, I think are critical, but we can begin the reform process the day after the budget revision is signed.”

Fitch said its “BBB” rating indicates “expectations of default risk remain low, although the rating is well below that of most other tax supported issuers.”

The ratings agency said California needs a balanced budget agreement quickly because it will need to sell short-term debt for cash-flow purposes once it has a spending plan.

Fitch analyst Douglas Offerman said the rating agency is keeping a close eye on how California manages its cash, sharply reduced as revenues have plunged amid recession, rising unemployment and a prolonged housing slump.

California is experiencing the worst drop in revenues from personal income taxes since the Great Depression.

“The (state) controller having to issue IOUs is one thing, but the controller’s own projection is that the state’s projected cash position in the fall gets dramatically worse without a resolution to the budget,” Offerman told Reuters.

“That raises the urgency to developing a budget solution that is going to address the cash-flow problem the state has in a responsible way,” he said.

Questions have arisen whether California’s tax-exempt IOUs can be bought, sold and traded.

The Securities and Exchange Commission must first determine if the IOUs are securities to regulate them, said Ernesto Lanza, general counsel to the Municipal Securities Rulemaking Board, adding that the board was not working directly with the commission on that decision.

“It looks like it has all the hallmarks of a security,” Lanza said. “If they are securities, I think they’re pretty clearly municipal securities.”

Fitch’s downgrade was seen having little effect Tuesday on the municipal debt market. “I don’t see any huge negative reaction, it’s priced in,” said Parker Colvin, head of municipal securities trading at Stone & Youngberg in San Francisco.

… S&P and Moody’s will be the next to cut California’s ratings. Democrats in the state legislature tell us we need more taxes to cover the shortfall. Being the highest taxed state in the nation is apparently still not enough. Meanwhile, one happy California state retiree after another enjoys pensions of over $100,000 per year.

The first IOUs have already been sent out. Some are offering to buy them for around 85 cents on the dollar:

Several posters on Craigslist are offering to purchase the warrants at a discount. One self-proclaimed investor in Maine will buy the IOUs for 69 percent of face value, while another will pay 80 cents on the dollar.

“If you need CASH now and have a CA issued IOU, please contact us immediately,” said another Craigslist ad, offering to pay 85 percent of face value. “While our state might be insolvent, we aren’t.”

… 85 cents on the dollar, plus a coupon of 3.75%, that would make the annualized yield of a California IOU approximately 63.75%. I doubt that this will be a prevailing market price, but it is certainly likely that some cash strapped recipients of IOUs will go for such deals.

The time has come. For only the 2nd time since the Great Depression, California sends out IOUs:

Reporting from Sacramento — Deep in debt and short on cash, California on Thursday churned out its first batch of IOUs in nearly two decades amid grumbles from bankers, growing public outrage and scant progress in negotiations to resolve the state’s widening budget deficit.

The state controller’s office fired up a pair of printing presses and began rolling out nearly 29,000 IOUs totaling more than $53 million, most of them destined for residents around the state still awaiting income tax refunds. Recipients also include some businesses, pensioners, health clinics, college students and many others who get checks from the state.

“We never thought we would do it again,” said Dorothy Cottrill, who manages check disbursement at the state controller’s office and still remembers the last time the state spun out IOUs in the lean days of 1992.

The unusual move came hours after a panel of state finance officials set the annual interest rate for the IOUs at 3.75% for banks and other financial institutions willing to accept the vouchers. Some banks, including Bank of America, Citi and Wells Fargo, have agreed to honor the paper, but only until July 10. Many recipients could receive their IOUs after that date.

Those who don’t have a bank that will cash the IOUs can redeem them from the state Oct. 2, or sooner if officials settle on a solution to the financial crisis.

Rodney K. Brown, president and chief executive of the California Bankers Assn., said the state’s failure to resolve the budget crisis “has placed a tremendous burden on California’s citizens, communities and banks.”

State officials estimated that without a budget resolution they will have to issue $3.2 billion in IOUs in July and $1.65 billion in August.

State Controller John Chiang said the IOUs “are a sign that the state is being fiscally mismanaged” and a precursor to further credit downgrades for California, already the lowest-rated state on Wall Street.

The IOUs come two days after state Senate Republicans, with the support of Gov. Arnold Schwarzenegger, blocked an eleventh-hour attempt by Democratic leaders to push through budget proposals that would have staved off the IOUs, at least temporarily.

Outside the Capitol, the mood was cross. Richard Blitz, a 73-year-old owner of a downtown Los Angeles variety store, said the IOUs seem a hollow gesture by a state government struggling for answers.

“It’s candy for a hungry man,” he said. “Banks will accept it for a week or two, but what will happen after that?”

Thomas Bent, medical director of the Laguna Beach Community Clinic, expects to receive more than $10,000 in IOUs and may be forced to dip into reserves after the big banks stop accepting them.

“I can’t pay bills with IOUs,” Bent said. “I can’t pay salaries with IOUs.”

Los Angeles County officials said they should have enough cash in the bank to operate unfettered through the summer and would cash its IOUs with Bank of America. They said that after the July 10 cutoff, the county might become something of a bank, purchasing the IOUs from institutions and individuals, then holding them until they can reap the interest from the state.

The county performed a similar role when the state issued IOUs 17 years ago.

With the state economy hobbled, tax receipts waning and the budget deficit continuing to grow, the governor declared a fiscal emergency Wednesday and ordered state workers to take a third unpaid furlough day each month. He also issued a new list of proposed cuts to schools and public universities to address a deficit that his finance team now says has swelled to $26.3 billion.

On Thursday, the Department of Motor Vehicles announced it will close its offices each of the Fridays that remain in July to comply with Schwarzenegger’s latest furlough order.

But the governor and legislative leaders remained divided on several fronts. Schwarzenegger wants to save money by tackling fraud and waste in the state’s health and welfare programs and to deflate state worker pensions. Democrats are pressing to retain as much as possible the state’s social safety net: welfare, children’s health insurance, in-home support for the elderly and other programs.

The governor said during an appearance in Los Angeles that lawmakers apparently have decided “it is more important to protect state employees and to protect all of the different people and labor and special interests, rather than protecting . . . the people of California, the taxpayers.”

A downcast Assembly Speaker Karen Bass (D-Los Angeles) blamed Schwarzenegger for linking a budget solution to his push for a government overhaul.

“Frankly, I have really begun to be concerned,” Bass said, adding that Schwarzenegger’s priority seems to be “fixing his legacy.”

An additional difficulty looms. Budget negotiators say it seems increasingly clear that a balanced budget could require suspending school funding guarantees embodied in Proposition 98 — and wrangling with the powerful California Teachers Assn.

Still, most lawmakers left the capital for the holiday weekend. Legislative leaders said they would remain behind to continue negotiations.

Meanwhile, the controller’s office pumped out the IOUs for only the second time since the Great Depression. The black-inked documents look like checks but have the words “registered warrant” emblazoned on them.

Workers placed the foot-high piles of paper promises into boxes for sorting, packing and shipping as news photographers watched.

The state’s Constitution requires that education and debt service payments be made — in cash — before all others. After that, those who must be paid in cash include state workers, the state’s CalPERS and CalSTRS pension funds, In-Home Supportive Services and Medi-Cal providers.

Please consider An Economy Bigger than Russia, Brazil, Canada, India or Spain Is About to Default:

An economy bigger than Russia, Brazil, Canada, India or Spain is in imminent risk of defaulting on its debts.

Which nation am I talking about?

Not a country . . . but the state of California.

California’s GDP was around $1.812 trillion in 2007.

According to the International Monetary Fund, that is bigger than the 2008 GDP of every country in the world except the US, Japan, China, Germany, France, UK and Italy.

… of course the author means the government of one of the biggest economies, not the economy itself.

The first IOUs are going out to people who were still waiting for their tax refunds. Lots of people who were expecting to receive cash are now receiving paper with a promise to get paid by October 2nd. Of course the state will do everything possible to push it out to this final date.

Of course this will add significantly to the ongoing drag on consumer spending and investment. Please note that other states may follow California’s example in the months to come. Also, the impact on the US as a whole seems to be rather underestimated at this point.

Aside from the states’ debt crisis, the commercial property implosion and accelerated credit card defaults are only just beginning to unfold. Roughly $2.5 trillion Alt-A resets are only just ahead of us. Whoever talks about a coming inflation and/or recovery is either not looking or fooling himself.

California is about to issue its first IOUs as a response to the budget crisis, State IOUs loom as foes’ battle lines harden:

Reporting from Sacramento — After trying for weeks to fix a state budget gone out of control, Gov. Arnold Schwarzenegger and state lawmakers stood frozen in conflict Wednesday with the state at the brink of a meltdown.

A day after the state Senate failed in a late-night bid to close part of a deficit now projected at $26.3 billion, California Controller John Chiang took steps to begin issuing IOUs today to tens of thousands of companies and individuals that are owed millions of dollars by the state.
…
When the scale of the budget crisis became clear in May, Bass, the governor and other state leaders expressed confidence that they could attend to it swiftly. A budget put in place in February to take the state through the middle of next year had fallen out of balance. Revenues declined amid a continuing economic downturn, and voters rejected a slate of ballot measures that were intended to raise nearly $6 billion.

I should point out that the scale of the budget crisis was clear for much longer than since May, unless your ability to look forward is limited to 1 month. I wrote about it in January (and others actually did way before me) …

California has to wake up to reality. Whether we like it or not, the state needs to stop paying unionized workers outrageous wages. Instead of reducing expenses for some departments and programs, it needs to dismantle and abolish entire departments and programs. It needs to stop funding unsustainable pension plans. In return it needs to drastically cut the overwhelming taxes and fees that are stifling its economy.

If it doesn’t do it now, then it will have to do it later, by declaring bankruptcy, which will completely wipe out all programs and departments that can then no longer be funded anyway.

The LA Times article concludes with:

The governor and lawmakers appeared resigned that they could no longer avoid the IOUs. A panel of finance officials will meet today to determine the interest rate for banks and other financial institutions that accept the IOUs. Some banks have already agreed to honor them, including Bank of America, which will accept the scrip until July 10. Other banks have not decided.

Note that BofA will be accepting IOUs until July 10th only. Then what? Time for California legislators to come to their senses and wake up to reality. Will they listen this time? Take your guess.