SAN FRANCISCO - If California lawmakers do not close the deficit in the state's approved budget, California could run out of cash and be forced to pay its bills with IOUs beginning in March, according to Controller John Chiang.

That's just one of the dire warnings the state's top fiscal officers gave lawmakers in a special joint session of the Legislature yesterday. California faces an $11 billion deficit in the $103.4 billion budget for fiscal 2008-2009, which was approved in September after a three-month budget standoff.

Republican legislators refuse to go along with new tax increases to balance the budget, and Democratic lawmakers refuse to balance the budget solely with spending cuts. A budget fix requires bipartisan approval because the state constitution requires a two-thirds majority to pass budget and tax measures. Gov. Arnold Schwarzenegger last month proposed a package of budget cuts and a sales tax hike that lawmakers of both parties opposed.

"We're likely going to run out of cash in March," said Garin Casaleggio, a spokesman for Chiang. "Our most recent estimates show that by the end of March, we will be $1.9 billion in the red."

Treasurer Bill Lockyer warned lawmakers that the state won't be able to tap the municipal bond market to solve the cash shortage with the budget in disarray. He added that some current infrastructure projects could grind to a halt in a just nine days because they depend on borrowing from the state's pooled investment fund until bonds are issued. If the state can't replenish the fund, it can't keep making those loans.

"Without a solution ASAP, state infrastructure financing is going to shut down," said Lockyer spokesman Tom Dresslar. He said that would have a "substantial negative effect" on the workers and companies that are already working on those state projects.

The state had to offer interest rates as high as 4.25% when it sold $5 billion of revenue anticipation notes in mid-October, just weeks after the failure of Lehman Brothers. Even after the credit market thawed somewhat, California's access remains constrained. The state's Department of Water Resources was only able to sell $173 million of $523 million of revenue bonds it offered last month.

The state - which typically keeps a $2.5 billion cash cushion on hand - will have to find ways to make some mandatory payments, even if lawmakers allow California's coffers to run dry in March.

In testimony yesterday afternoon, Chiang described the state's options, including delaying discretionary payments, issuing IOUs - or registered warrants - for some mandatory payments, and inter-fund borrowing.

He said balancing the budget swiftly is the by far the best option.

California law allows the controller to pay bills like tax refunds and vendor payments with the interest-bearing warrants, or IOUs in common usage. The warrants are sent to individual creditors rather than being issued in financial markets.

Issuing warrants for certain payments would enable the state to use cash for mandatory payments for such things as debt service and school aid payments. Warrants are also not permitted to pay MediCal payments or salaries of workers covered under the Fair Labor Standards Act.

Chiang said the law governing use of such warrants is unclear in a situation where the state has an approved budget, as it does now. California has only used them twice, once during the Great Depression and again during a budget impasse in 1992. He also warned that the state could face lawsuits from vendors paid with warrants.

"The controller is not advocating for issuing IOUs," said spokesman Casaleggio. "It sends the wrong message to our creditors."

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