California starts issuing IOUs as bankruptcy nears

I just picked up two reports on California’s desperate situation. California, whose legislature and Governor have been hold up in around the clock negotiations, is now issuing IOU’s instead of cash. They have also been downgraded by Moody’s credit rating agency. The first story came from the well-known political site Monsters & Critics.  And it demonstrates that California is on the verge of bankruptcy:

The world’s eighth largest economy started issuing IOU (I-owe-you) vouchers instead of checks Monday as an ongoing budget battle and a 42-billion-dollar deficit left the state without enough cash to meet its commitments.

Governor Arnold Schwarzenegger was meeting with legislators in a bid to resolve the standoff that has prevented the state from passing a budget. State comptroller John Ching has warned that the state could completely run out of cash by the end of this month if a solution is not found.

On Friday tens of thousands of state workers will begin taking two days a month of forced leave without pay.

A representative for the state’s Department of Finance said checks were not being issued for Cal Grant college scholarships, county social services and the California Highway Patrol. No state tax rebates will be issued until a plan is adopted to deal with the state’s huge deficit, the Department of Finance said.

Schwarzenegger has declared a fiscal emergency as California faces a 42-billion-dollar deficit through June 2010. The massive US state has been hard hit by the recession which has seen housing prices plunge and revenues dry up.

Issuing state bonds is also tough given the paralysis in the credit markets and a credit downgrade because of the lack of a budget. Attempts to bridge the gap through a combination of spending cuts and tax hikes have been stymied by Republican legislators who reject any new taxes.

But, that’s not all, MarketWatch has picked up a press release showing that California’s short-term debt is being downgraded from F-1 to F-2 (Hat tip Paul Kedrosky). And even this downgrade is predicated on California resolving its crisis (see my highlight in bold).

Fitch Ratings has downgraded the short-term rating on the State of California’s $5 billion 2008-09 revenue anticipation notes (RANs, or the notes) to ‘F2’ from ‘F1’. The downgrade is based on the severe erosion of state revenues and cash resources since note issuance, prompting payment deferrals while the state develops solutions to its deficits.
Since the notes were sold in October the state’s baseline forecast of fiscal 2008-09 cash receipts has dropped by 13%, to $89 billion. Although negotiations are underway on a $42 billion package of cash and budgetary solutions for this fiscal year and next, even with near-term action the state is likely to confront another downward forecast revision in the spring, as economic and revenue performance has worsened since the current forecast was completed in November. In the absence of corrective measures to date, the eroding cash situation has caused the controller to begin payment deferrals in order to ensure sufficient resources for constitutional and statutory priorities.

The downgrade to ‘F2’ assumes that the state takes action to alleviate near-term cash pressures. Fitch’s long-term rating on the state’s general obligation (GO) bonds, currently at ‘A+’, Rating Watch Negative, will be reviewed in the coming weeks based on the state’s ability to agree upon budgetary solutions, and the effectiveness and completeness of those solutions.

This news is sure to roil the municipal bond market because California will be seen as a harbinger of things to come on the state and municipal level. Not being able to print your own money will mean bankruptcy for many states and municipalities.

Near bankruptcy, California starts issuing IOU’s instead of checks – Monsters & Critics
Fitch Downgrades California’s $5B RANs to ‘F2’ – MarketWatch

  1. Emma says

    A few quick questions for you:
    When are property tax bills issued in most States?
    Are the assessments based on market value of the homes?
    How many months “lag” are inherent in these “fair market values” that the assessments are marked to? 6 months perhaps? What are the implications when housing prices are dropping so fast?
    If homeowners are unable to pay inflated tax bills by the deadline, does this mean forced foreclosures?
    How do the various mortgages deal with this?
    Is the property tax portion included in the mortgage payment for most homeowners?
    If there is any issue related to this, when would the effects be seen? May?
    Are these potential negative effects related to unpaid property taxes being used in the revenue forecasts by various municipalities and States such as California?

    OK, I know you may not be able to address all of these questions, I’m just wondering if there are potential problems in this area that aren’t being addressed.

    1. Edward Harrison says

      Emma, here’s what I know. Property taxes are issued based on a tax assessment by the sate or municipality. This assessment is different from the one given when a house is for sale. In making the assessment, the appraiser does an appraisal of the land value and structure value. ALl of this information is publicly available. For example, where I live, in the DC area, one can find the tax assessment value of any home online at

      In California, however, there is a kink in order to keep property taxes from skyrocketing. The law is proposition 13 and it is designed to keep taxes down. This was a key issue in the last gubernatorial election.

      As for the other intricacies, Wikipedia has a good entry on ho the process works. Note that the assessments are usually not set in stone. One can appeal if one thinks the assessment is too high. For years, in the DC area, property tax assessed value lagged the market value by a good margin, but with prices falling, this is changing and more appeals should be expected.

      I hope that answers most of your questions.


  2. Terry says

    A quick solution to the California budget crisis: Pay the state legislators with IOUs. We’ll soon see how long their political ideology continues to confound the state’s economic need.

  3. C. Brunetti says

    This is a bit mind boggling! To think of a state handing out IOUs!! I also don’t understand how this will help anything in the long run. I really like Terry’s idea of paying state legislators with IOUs.

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