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California Hands Out More IOUs

California wrote another 12,500 IOUs on Tuesday rather than pay all its bills in cash, the latest chapter in the financial mess engulfing the nation's most populous state.

Last week's decision by state Controller John Chiang to issue "registered warrants" instead of checks to taxpayers owed refunds, vendors and other groups was the most dramatic step a state has taken this year to confront billions of dollars in budget shortfalls. A total of 72,000 IOUs have been written since last week.

Gov. Arnold Schwarzenegger, a Republican, and the Democratic-controlled Legislature have been unable to agree on a package of spending cuts and tax increases to close a massive budget gap.

The result is a standstill - and IOUs that reached a total of $109 million Tuesday.

California issued IOUs in 1992 during a 61-day budget impasse. Some states issued IOUs during the Depression. The notes, now worthless, can be purchased at antique shops, says Chicago bankruptcy attorney James Spiotto, an expert in government finance. Spiotto says he doesn't know of any state other than California to issue IOUs since the Great Depression.

Massive shortfall

The state says it has a $26 billion shortfall in its $90 billion general fund for the 2010 fiscal year that started July 1, but it's unclear what this means. The general fund accounts for less than half of state spending and doesn't include, for example, $55 billion in federal stimulus money the state is getting.

Spiotto says IOUs are a pressure tactic to encourage a budget agreement.

"It's a form of dramatic theater," says Spiotto, head of the bankruptcy committee of the National Association of Bond Lawyers. "It's an effort to highlight the budget problem and force people to act like grown-ups."

Spiotto says states have power, under the U.S. Constitution, to stop paying bills if they run short of cash, and that's what typically happens.

Alabama, Illinois and Pennsylvania are among the states doing this now.

Illinois is 101 business days late on $2.4 billion in bills but hasn't considered IOUs. "It's not that we've run out of cash," says Carol Knowles, spokeswoman for the Illinois comptroller. "We're always out of cash."

Alabama is withholding $63 million in tax refunds to 123,000 residents. It didn't consider IOUs either, says Alabama Revenue Department spokeswoman Carla Snellgrove. The state hopes to have enough cash - through normal tax collections - to write the checks by July 16, when the state must start paying a penalty on the late payments, she says.

California delayed paying bills for 30 days when it ran $350 million short of cash in February.

The controller decided to write IOUs now because of the magnitude of the state's money problems and to avoid costly penalties on late payments, says Jacob Roper, a spokesman for the controller's office.

The state estimates it will come up $2.8 billion short of the $14 billion needed for July's bills and needs to issue more than $6 billion in IOUs by September if the budget isn't fixed.

Some payments in cash

The warrants look like ordinary, green-colored state checks. However, words have been added at the top saying the warrants have an Oct. 2 maturity date. The IOUs pay a 3.75% annual interest rate that is tax free - worth about $9 of interest on a $1,000 warrant held until Oct. 2.

California will pay tax refunds, college aid and welfare checks with IOUs. Others - bondholders, employees, health care providers - will be paid cash.

The state's major banks say they will treat the IOUs like cash until Friday. After that, they will stop accepting them. The deadline is firm, says Julia Bernard of Wells Fargo Bank.

One state whose financial strategy starkly contrasts with California's is Florida. The Sunshine State's tax revenue fell 13% this year, similar to the drop in California.

The Florida Legislature took action: @It raised taxes, cut spending and used stimulus money to balance its budget. It went home May 8. "We have a tradition of living within our means," says state Rep. David Rivera, a Republican who is chairman of the Joint Legislative Budget Commission.

California has run budget deficits every year since 2002, according to its financial statement. The state has covered approximately $100 billion in deficits since then by borrowing, transferring money between funds and using accounting tricks.

Rivera calls the California budget "a mess" and opposes any federal bailout of the state. Asked whether Florida would consider issuing IOUs in a crisis, he replied, "No, no, no, no, no, no, no. Are you kidding?"

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