What will spur California to solve its budget crisis?

Major banks say they won't honor IOUs that the state has issued. That could increase pressure on lawmakers – but it might not be the decisive factor.

By , Staff writer

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    A man reads a sign at a closed Department of Motor Vehicles office in Santa Clara, Calif. Most California state government offices are beginning a new series of closures three Fridays a month.
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It’s Furlough Friday across California. And if you’re holding one of the 91,213 IOUs issued by the state since July 2, have fun getting it cashed after this week.

Pressure is indeed mounting on lawmakers to find some solution to the $26.3 billion budget gap. Many state workers aren't very happy, since they're essentially taking a 14.2 percent pay cut. The pay reduction is the result of a new series of unpaid days off, which thousands of them are taking to save California $1.3 billion.

Major banks are also pushing back: Bank of America, Wells Fargo, Chase, and Citigroup say they won’t honor those IOUs, which California began sending to vendors and taxpayers after it started the new fiscal year minus a budget.

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But will lawmakers feel the pressure? Will the shuttered state offices and threats by big banks spur some action in Sacramento?

If vendors who have received IOUs can’t pay their bills, they won’t keep quiet about their hardships – and that will be a clear message that it’s time to end the impasse, says Tim Hodson, executive director of the Center for California Studies at Sacramento State University.

But California Democrats and Republican Gov. Arnold Schwarzenegger remain at loggerheads. Republicans want cuts to what they call excessive waste in welfare programs. Democrats say the state needs more revenue so it doesn't have to slash valuable services already trimmed to the bone.

“It’s one thing to hold onto your ideological beliefs when no one close to you is harmed. It’s another thing to have constituents call you up to say, ‘I can’t make payroll because of this,’ ” Mr. Hodson says.

While ire over IOUs could certainly become a motivator, it’s not quite enough to bring about a resolution, says economist Stephen Levy.

“It’s another piece of the embarrassment of not being able to reach an agreement,” says Mr. Levy, director of the Center for Continuing Study of the California Economy in Palo Alto.

Recently, California’s bond rating was lowered. But if that wasn’t enough to motivate action, Levy doubts that the banks can prod the politicians to compromise. “Once we’ve gotten this far, I can’t imagine that the IOUs will change the gridlock that is going on.... I’m not sure what the event will be that sends a message to legislators that they need to find a solution,” he says.

The crisis could extend into August, some analysts suggest. That’s when fiscal experts say the state will finally fall into the red.

The state, Levy says, will find a way to ensure that the more than $354 million in IOUs already issued – and the forthcoming ones – will be honored. But if the big banks refuse them, it will be a big inconvenience. Anyone with an IOU can have it redeemed by the state on Oct. 2 along with 3.75 percent annualized interest.

On Thursday, the US Securities and Exchange Commission ruled that the IOUs are protected by securities law and can be traded or exchanged only by registered brokers and dealers.

Also, even if major banks aren’t taking the IOUs, credit unions are still willing to accept them.

When the state found itself in a similar situation in 1992 and began giving out IOUs, banks also eventually refused them (they were called registered warrants at the time). This time around, a Bank of America spokeswoman told the Los Angeles Times, they’ll help customers on a case-by-case basis. But “it doesn’t provide any incentive for the state to reach an agreement if we just accept the IOUs through perpetuity,” said the spokeswoman, Britney Sheehan.

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