California declares fiscal emergency

California Gov. Arnold Schwarzenegger declared a fiscal emergency on Wednesday, forcing lawmakers to tackle a budget gap that has raised the prospect of drastic measures to keep the state working.

Lawmakers debated late into the night Tuesday but could not agree on a plan to balance California’s budget — now showing a deficit of $26.3 billion — in time for the new fiscal year, which began on Wednesday.

That left state officials with no choice but to prepare for suspension of payments to vendors and local agencies which instead will get “IOU” notes promising payment.

The most populous U.S. state — the eighth-largest economy in the world in 2006 — now risks further cuts to its credit ratings, which would increase its borrowing costs when coffers are already stretched to breaking point.

“Though the legislature failed to solve our budget problem yesterday, rest assured that solving the entire deficit remains my first and only priority, and I will not rest until we get it done. I will not be a part of pushing this crisis down the road — the road stops here,” Schwarzenegger said in a statement.

California lawmakers struggle with budget deadlines nearly every year but this budget fight is taking place amid the state’s worst drop in revenues from personal income taxes since the Great Depression as recession and rising joblessness worsen damage done to the state economy by the housing slump.

Democrats, who control the legislature, and Republicans agree on the need for spending cuts but are split over whether to raise taxes to help fill the gap.

Republican lawmakers and Schwarzenegger, also a Republican, have ruled out tax increases. They want deep spending cuts to balance the budget. Democrats say that would slash the state’s safety net for the needy to the bone.

By declaring a fiscal emergency, former Hollywood action star Schwarzenegger is forcing lawmakers to focus on plugging the budget gap.

Assembly Majority Leader Alberto Torrico said Democrats would press the governor to back their budget plan, which they believe some Republicans will inevitably support. “He can issue as many edicts as he wants,” Torrico said. “We’re going to keep sending it to him until he signs it.”

California bonds due in 10 to 30 years traded stronger in the secondary municipal debt market after suffering in recent weeks on the growing crisis in California, said Municipal Market Data analyst Domenic Vonella.

CASH CRISIS LOOMS

The White House said it was keeping a close eye on California’s woes but, after federal coffers were stretched with massive bailouts of the U.S. financial sector and automakers, it did not hold out an offer of help.

Officials from several states have proposed Washington help with more aid or by vouching for state debt. “We continue to watch the situation and we’ll see as it develops,” White House spokesman Robert Gibbs said.

California’s treasurer was preparing plans to issue short-term debt assuming Washington will not guarantee it. “We did not ask for a bailout, repeat, we did not ask for a bailout. We wanted the federal government to step in and provide a backstop for our cash-flow borrowing,” said spokesman Tom Dresslar.

Meanwhile, California’s lack of a budget may trigger action by Wall Street credit ratings agencies, which have warned they may lower the state’s rating further.

Fitch last week downgraded California’s general obligation debt by one notch to A-minus, four notches above speculative “junk” status, making it the lowest rating of any U.S. state.

Fitch and Moody’s had no immediate comment on California’s IOU plan or failure to pass a budget. Standard & Poor’s said in a statement it affirmed its A rating on the state’s general obligation debt, but kept it on CreditWatch with negative implications.

“Should the current impasse over a budget revision remain unresolved long enough that the state’s cash management actions no longer are sufficient to effectively insulate its priority payments — including debt service — the state’s GO rating will likely be lowered, possibly to below ‘A-‘,” S&P said.

In Sacramento, tempers flared in the state Senate as the midnight start of the new fiscal year and the prospect of IOUs — last used 17 years ago — neared.

“There is no excuse to hold this whole state hostage,” state Senate President Pro Tem Darrell Steinberg told Republicans during a floor debate.

Senate Republican Leader Dennis Hollingsworth countered that major cuts are urgently needed. Otherwise, “there will be entire programs that will have to be lopped off,” he said.

California risks being unable to pay all of its bills this month. State Controller Chiang plans to issue IOUs by Thursday to state vendors, some local agencies and to the elderly, disabled and college students who receive state aid.

Bank of America said it would accept IOUs from customers through July 10, becoming one of the first major commercial banks to jump on board the program.

Chiang plans to send $3.36 billion in IOUs this month to help the state make $10.9 billion in other payments, including money owed to investors holding California’s debt.

“California has never defaulted on its debt obligation and we don’t plan to do so,” he told Reuters.

California needs to reassure Wall Street it can pay its debts because state officials need to sell $7 billion to $9 billion of short-term debt once there is a budget agreement.

“Absent a credible budget revision package, we believe the state may suffer insufficient investor confidence in its finances to successfully place such an offering,” S&P said.

Source: Reuters