SAN FRANCISCO — California Treasurer Bill Lockyer late Wednesday formally asked the U.S. Treasury to use Troubled Asset Relief Program funds to back state and local cash-flow borrowing.

Lockyer is asking the federal government to agree to buy tax and revenue anticipation notes or revenue anticipation warrants from letter-of-credit banks if a state or local government defaults on the debts.

The idea is to soothe banks’ fears about providing credit enhancement for governments that are facing declining and unpredictable revenue collections because of the economic meltdown.

“If we cannot obtain our usual short-term cash-flow borrowings, there could be devastating impacts on the ability of the state or other governments to provide essential services,” Lockyer said in a letter to Treasury Secretary Timothy Geithner.

California faces a cash-flow shortage of $13 billion or more next year. It hopes to borrow to ride out the crisis, but with revenue collections repeatedly falling below projections, officials don’t expect to find banks to back the debt. Without credit enhancement, California would face punishing interest rates. Lockyer spokesman Tom Dresslar said the state could be forced to pay as much as $1 billion in interest on $15 billion of short-term notes.

If the state failed to sell the debt, it could end up with more bills coming due than cash coming in as soon as July. It would have to delay payments, which could bankrupt some local school districts, Lockyer said. Seventy-five percent of California’s general fund budget is spent on aid to schools, social service payments to counties, and other local aid.

Local governments have sought help from TARP and the federal government several times in the past two years. The Federal Reserve and the Treasury have rebuffed earlier efforts to provide federal liquidity for variable-rate debt or for auction-rate securities. They have approved TARP funding for a widening group of private interests, including banks, automakers, and insurance companies. Lockyer argued that state and local governments may also be systemically important and are directly related to the public interest the program seeks to protect.

The Treasury press office did not return calls seeking comment yesterday.

Dresslar said Lockyer had been in touch with Treasury officials about his plan and submitted a specific proposal yesterday after having had more general conversations on Monday.

The proposal would require state or local governments to pay 100 basis points for the federal guarantee. It would use banks as intermediaries in a program, but the banks would take no credit risk.

Under Lockyer’s proposal, the banks would issue letters of credit. If a state or local government defaulted on its tax and revenue anticipation notes, the banks would buy them from investors. The Treasury would simultaneously buy the Trans from the banks.

The banks are needed in the transactions because federal tax law prohibits direct federal guarantees of tax-exempt debt. The program would have to be structured to ensure banks aren’t punished for participation, Lockyer said. Under the TARP legislation, banks must give Treasury assets in exchange for taking the toxic debt off their books.

“Although the notes in the proposed program will be purchased from the banks which provide credit support for state and local government Trans ... the objective of this program is to assist the states and local governments that are in need of funding, and not to assist the banks as such,” Lockyer’s proposal said.

Lockyer was keen to show that California is not seeking a federal “giveaway.” His proposal would only be in force for up to four years.

The “risk of eventual nonpayment is virtually nil because municipalities must repay their debts eventually,” the proposal said. “These are ultimately much better assets than many of the 'toxic’ assets TARP was originally created to remove from the financial system.”

Andrew Ackerman contributed to this story.

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