California to stop issuing IOUs

SACRAMENTO, CA The decision came after meetings between Controller John Chiang, Treasurer Bill Lockyer and Gov. Arnold Schwarzenegger's financial advisers, who needed to review California's cash flow and assess investors' appetite for buying California bonds.

When Schwarzenegger signed California's revised $85 billion budget two weeks ago, it gave the state the leeway to seek short-term loans to cover its daily expenses, ending the need for the IOUs.

"The state of California owes a debt of gratitude to the thousands of individuals and businesses that were forced to bear the brunt of the state's chronic fiscal mismanagement," Chiang said in a statement announcing his decision.

Chiang said he is confident he will be able to get an interim loan of $1.5 billion by Aug. 28, allowing the state to start cashing the IOUs given to individuals and businesses.

The state started issuing IOUs at the beginning of July, sending them to taxpayers who were owed refunds and state vendors that provide an array of products and services, such as office supplies, equipment and janitorial services.

The registered warrants carry an interest rate of 3.75 percent and can be redeemed starting Sept. 4 if a board Chiang sits on approves his recommendation next week, which is expected to be a formality. Several banks offered to cash them sooner but quickly halted the practice, and some people ran online ads offering to buy the warrants from cash-strapped IOU holders, often at less than full value. There appeared to be few takers.

Chiang called the issuance of 327,000 IOUs totaling $1.95 billion a difficult and shameful chapter in California history. It was just the second time since the Great Depression and the first time since 1992 that the state has issued promissory notes instead of payments.

Lockyer, the state treasurer who helped devise the borrowing plan, said ending the IOUs will rid California of the stigma caused by its financial distress.

"This plan is a crucial step toward restoring some fiscal order to California," he said in a statement.

He also said the state will need to borrow $10.5 billion for the coming fiscal year to meet its operating expenses. The treasurer's office said it will begin selling the $10.5 billion in bonds in mid-September.

The state began issuing the IOUs to preserve cash until California found a way to close a budget deficit projected at $24 billion through the middle of next year.

State officials hoped California's revised spending plan -- with deep cuts to children's health care, higher education and other state programs -- gives investors enough confidence to resume lending to the state. California has come to rely on taking out billions of dollars in short-term loans to cover payments during the first half of each fiscal year until most of its tax revenue arrives in the spring.

While the end of the IOUs is a milestone in California's ongoing fiscal crisis, some vendors said it would be months before their businesses would return to normal.

Gloria Freeman, who owns a temporary staffing agency in Rocklin, a suburb of the state capital, said the state already was six months behind on payments when it began issuing the IOUs. She deposited the state warrants with her bank but has not received payment for them.

Freeman said she is not sure when she will be able to replace the five employees she was forced to lay off. Her firm, Staff USA Inc., provides temporary medical staff to state prisons and mental health offices.

"They are so far behind in payment," she said. "It would be like me saying to you, 'Are going to make your car payment when you haven't received any money from your ex for a year?"'

State officials want to avoid longer-term debt, especially since the fiscal crisis sent California's credit rating to the lowest of any state, which means borrowing will be more expensive.

The recession has hit California's economy particularly hard, leading to a 34 percent drop in personal income tax during the first half of the year. Even an agreement in February between lawmakers and Schwarzenegger to raise income, sales and vehicle taxes was not enough to keep up with the steep pace of decline, leading to the massive deficit.

The IOUs were needed until lawmakers brought state spending obligations in line with tax revenue, which they did with the revised budget.

The latest state cash-flow figures suggest possible signs of life for California's economy, which accounts for 12 percent of the nation's gross domestic product.

While personal income taxes fell 11.5 percent in July compared with the previous year, sales taxes were up 20.8 percent, according to the controller's office. Corporate taxes rose by 9.1 percent from July 2008.

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