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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.

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"If the federal government has to determine who gets $6 billion and who gets $10 billion, there's likely to be a lot of finger-pointing. People will be very angry if politics becomes the methodology – there are real issues that are critical to determine. We've never been there before."

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Scott Pattison, executive director for the National Association of State Budget Officers, says "about 10 to 12 states in the next few months might have to go on market for a RAN [short-term bonds called Revenue Anticipatory Notes]."

Most states have rainy day funds they are dipping into during the current revenue crisis. Other states may be forced to raise taxes, cut services, or do both, he says.

Optimism after Massachusetts' sale

California needs to make up a $7 billion shortfall. But state Finance Department spokesman H.D. Palmer says this week's bond sale will attempt to collect only $4 billion.

"Given the market conditions, we concluded it was best to go only for $4 billion immediately and try for $3 billion more in a few weeks," he says.

Because Massachusetts successfully marketed $700 million in bonds last week, Palmer says Governor Schwarzenegger is "cautiously optimistic."

The state sent a letter to Henry Paulson last week saying that if the bond sale doesn't work, officials hope to borrow from the US Treasury under the recently signed Troubled Asset Relief Program (TARP).

"The Treasury hasn't answered yet," says Nick Johnson, director of the state fiscal project for the Center for Budget Planning and Priorities. "There's some discussion on whether or not they have legal authority to do so."

The issue to watch, say several state fiscal analysts, will be whether the credit markets will be able to loan money to California and other states. If not, it sends a dire signal to the rest of the country's businesses.

"States are the safest loans out there with the exception of a loan to the US federal government," says Donald Boyd, a state fiscal analyst with the Rockefeller Institute of Government, the public policy research arm of the State University of New York.

"They have very diverse economies, have the power to tax, and cannot go bankrupt. How can General Motors get a loan, if the state of Massachusetts cannot?"