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California Ready to Hand Out IOUs

SAN FRANCISCO - California is poised to begin paying some bills with IOUs today after efforts to pass budget-balancing legislation before a Tuesday night deadline failed.

Facing a $24 billion deficit for the fiscal year that began yesterday, negotiations over a solution broke down in a battle of brinkmanship that went over the brink.

Barring any sudden reversals, state officials are scheduled this morning to set an interest rate for registered warrants, or IOUs, that it will begin issuing later today to several classes of creditors, including local governments, vendors, and taxpayers owed refunds. They would be redeemed in October, if the state has enough money then.

Controller John Chiang has said that he must issue IOUs to some creditors in order to preserve scarce cash for creditors that hold state constitutional or legal priority, including bondholders.

Tuesday night's drama centered on a package of three bills that would have enacted more than $3 billion in budget cuts attributable to the fiscal 2009 fiscal year.

The cuts in those three bills had been endorsed by Republican Gov. Arnold Schwarzenegger and the leadership of the Democratic majorities in the Legislature.

But the cuts, primarily to education, had to be enacted before the fiscal year closed, according to the Democratic leadership.

Those stopgap bills required two-thirds votes as urgency bills, meaning some Republican support would be needed, and they cleared the Assembly on bipartisan votes.

But Schwarzenegger, backed by Senate Republicans, said he would veto anything short of a complete plan to resolve the entire deficit, and GOP senators refused to provide the necessary votes Tuesday night as the clock ticked toward midnight.

Democrats' proposals were all but meaningless, the governor said at a press conference yesterday.

"They presented cuts that meant absolutely nothing in the out years," he said.

The actual budget impact of the bills' failure is greater than the $3.3 billion in foregone spending cuts, according to Senate Democratic spokeswoman Alicia Trost.

Under the state constitution's complicated formula for K-12 spending, the failure to cut education spending in fiscal 2009 has increased California's mandated education spending by $3.6 billion in fiscal 2010, she said in an e-mail.

"It is without question the most irresponsible act I have seen in my 15 years of public service," Senate President pro tempore Darrell Steinberg told the media after midnight. "It is a major blunder."

Schwarzenegger's finance director, Michael Genest, yesterday put a $2 billion figure on the lost opportunities for savings because of the fiscal year's end.

Yesterday, the governor reiterated his demand for lawmakers to approve a full solution to the deficit, and declared a fiscal emergency. Under the terms of the declaration, a special session is declared and the Legislature has 45 days to pass and send a bill or bills to the governor's desk addressing the budget crisis, and if it fails to do so, it cannot adjourn or act on other bills.

Genest added that if a balanced budget is adopted soon, one that shows investors the state can repay them next year, he believes the state can probably still access the markets for a cash-flow borrowing by issuing revenue anticipation notes, though time is running short.

"It's getting riskier and riskier," he said yesterday. "It would have been a lot better if we had done this yesterday."

The issuance of IOUs complicates the matter, Genest said, because it gives potential investors in revenue anticipation notes more reasons to doubt the state's ability to repay the short-term debt.

Budget writers received even more bad news this week from a state appeals court, which ruled that recent budget shifts from local transit agencies to the state general fund violated the state constitution.

The state government is appealing that decision, Genest said.

The ultimate impact to the budget, for past years and current years, would be $3.4 billion, he said. That number is not reflected in the budget plan, he added, because the state expects to win the case and, even if it doesn't, such a ruling isn't likely within the next year.

"Could that conceivably happen in the [2009-2010] fiscal year? It doesn't seem that likely to me," Genest said.

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