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Are states next in line for federal bailout?

A bond sale this week will test whether private capital can meet California's shortfall.

By Daniel B. WoodStaff writer of The Christian Science Monitor / October 15, 2008

Los Angeles

How California fares with a $4 billion short-term bond sale this week will help answer a key question looming over the current US financial crisis: are traditional credit markets so frozen that states won't be able to raise revenues to tide them over their cash crunch?

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The practice of selling short-term bonds is used regularly by at least a dozen US states, and occasionally by several more, to keep state programs and services running smoothly year round.

Because tax income is not steady throughout the year – far more revenue comes in from September through December than January through March – California and others (including Massachusetts, New Jersey, Nevada, Rhode Island, Arizona, Delaware, New York, Florida, and Alabama) borrow short-term to pay their bills when revenues are temporarily insufficient.

Now, with states facing the same problem faced by millions of businesses – tightening credit markets – at the same time that revenues are sinking, many budget officials are worried that they may not be able to borrow when they need to.

Will states turn to Washington?

Some, including California, have notified US Treasury Secretary Henry Paulson that if the credit markets don't come through, they may be knocking on his door.

There is currently no formal mechanism in place for the federal government to provide loans to states unless the need is generated by a natural disaster, say experts.

By law, states have to balance their budgets each year. If several go to the federal government and line up all at once, who will decide which states gets the limited – and dwindling – funds?

"This is an unprecedented situation because of the scope of the lending needs," says Alan Rubin, director of federal government relations for Buchanan Ingersoll & Rooney, which has decades of experience in state financing. "If these states can't get their funds the usual way and start asking the federal government, there is no clear-cut way for Washington to respond."

The federal government is best prepared to come through with funding after disasters – such as Katrina or 9/11 – says Mr. Rubin and others.

"This could pit states against each other in very uncomfortable ways," says Rubin.