Rebel Traders – Analysis Without The Hype

The California budget is in a ‘precarious’ condition. Once again California is bleeding money, and there are not enough band aids to control the bleeding.

California Controller John Chiang has stated that the state may have to issue IOUs for the second time in as many years. California has a $20 Billion budget deficit.

“If solutions are slow to emerge and if they are neither credible nor sustainable, California will once again be unable to timely meet all of its payment obligations and my office will be forced to seek costly emergency financing, or conserve cash by delaying payments or issuing IOUs,” Chiang wrote.

The state issued $2.6 billion of the vouchers last year to pay bills, resorting to promissory notes instead of cash for the second time since the Great Depression as Schwarzenegger and the Legislature were deadlocked over how to close an imbalance that totaled $26 billion at the time. The tactic allowed it to preserve cash for the highest-priority bills, including payments to bondholders, until an accord was reached and the state was able to sell debt to generate funds. […] (Bloomberg)

When California issued IOUs last year it created more hardship for small businesses and residents who were already hurting for cash. If California repeats the same IOU program we can expect to see a trickle down effect of more small business failures and an increase in delinquency rates in all forms of credit products, including mortgage payments.

Remember last year when California was so cash poor they had to issue IOU’s instead of actual payments. (See December 31, 2008 post “tax refunds in California may be IOU’s”).

Well now it is Déjà vu again.

California is facing yet another cash crunch this year, and on top of that their debt rating was just cut to A- over the deepening budget situation.

Standard & Poor’s on Wednesday cut its rating on California’s $64 billion in general-obligation debt to A-minus from A and warned that the outlook was "negative," meaning another reduction could loom.

S&P cited new concerns about the state’s finances, including a possible cash shortage "if the state’s revenue and spending trajectories continue."

Scrambling to close a $20-billion budget gap, Gov. Arnold Schwarzenegger has proposed a number of one-time fixes — including having the federal government contribute nearly $7 billion in new aid. Yet the state’s chief budget analyst believes the odds of getting that much help from the U.S. are "almost nonexistent."

S&P worries that the state could face a cash crunch in March, before it receives the income tax payments due in April.

"There could be days in March when they go into a negative cash position," said Gabriel Petek, an S&P analyst in San Francisco.

Although Petek said he didn’t believe California would be in jeopardy of missing any payments due on its debt, he said the government might again pay other obligations with IOUs, or the state might again require a short-term loan from Wall Street.(Source: LA Times)

This sounds very similar to the situation one year ago, although this time the credit rating has deteriorated, and so to has the fiscal outlook for California. I sure would hate to be expecting a tax refund in California this year (again).

Well if California residents don’t have enough problems already. Now the IOUs that the state government has been issuing as payment will no longer be accepted by major banks starting this Friday.

A group of the biggest U.S. banks said they would stop accepting California’s IOUs on Friday, adding pressure on the state to close its $26.3 billion annual budget gap.

he development is the latest twist in California’s struggle to deal with the effects of the recession. After state leaders failed to agree on budget solutions last week, California began issuing IOUs — or “individual registered warrants” — to hundreds of thousands of creditors. State Controller John Chiang said that without IOUs, California would run out of cash by July’s end.

But now, if California continues to issue the IOUs, creditors will be forced to hold on to them until they mature on Oct. 2, or find other banks to honor them. When the IOUs mature, holders will be paid back directly by the state at an annual 3.75% interest rate. Some banks might also work with creditors to come up with an interim solution, such as extending them a line of credit, said Beth Mills, a California Bankers Association spokeswoman.[...]

The group of banks included Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co., among others. The banks had previously committed to accepting state IOUs as payment. California plans to issue more than $3 billion of IOUs in July.[...] (Source: WSJ)

What a disgrace, fist these super ‘too big to fail’ financial institutions get bailed out with tax payer funds and then turn around and stiff the public.

Now that California is issuing IOU’s as payment Fitch Ratings has cut the credit worthiness to BBB – two notches above ‘junk status’.

Further downgrades are possible, Fitch said, if legislators and Arnold Schwarzenegger, governor, do not end a stalemate over how to close a $26bn budget gap. “This underscores the urgency to solve our entire deficit,” Mr Schwarzenegger said.

By issuing the IOUs for what is considered non-priority payments, including vendor bills and tax refunds, the state is taking steps to ensure debt service on California’s nearly $70bn in general obligations bonds, Douglas Offerman, an analyst at Fitch, said.[...]

The use of IOUs for non-priority payments would offset cash shortfalls into September 2009, as currently projected, Fitch said. But by the end of October the projected cash deficit expands to $16bn, beyond non-priority spending of $10.6bn, excluding tax refunds. The rating, which is four notches below that by Fitch for any other state, is Fitch’s second cut for California in the past few weeks. At the previous single A minus, California already had Fitch’s lowest rating. It is rated at single A level by Moody’s Investors Service and Standard & Poor’s.

Tom Dresslar, spokesman for California state treasurer Bill Lockyer, said: “It is hardly surprising; nevertheless, it is always disappointing, especially for a state that is already at the bottom of the ladder when it comes to credit ratings.”

He added: “The folks who will pay the price are tax-papers when we go to market to sell infrastructure bonds. It will cost taxpayers more money to build their schools, roads, levies, affordable housing.”

California bonds began weakening late in the day. Long-term debt has been yielding just over 6 per cent, about a full percentage point more than other state bonds.[...] (Source: Financial Times)

California is now in crisis mode with little cash on hand. Contractors and individuals who are still waiting for tax refunds will instead an IOU.

Update: The following chart from reuters

With budget negotiators at loggerheads and California government facing a cash crisis, the state controller’s office will start printing IOUs this afternoon for the first time in 17 years.

The presses are set to start at 2 p.m., churning out 28,742 IOUs worth $53.3 million that will be dispatched mostly to residents throughout the state still awaiting their income-tax refunds.

State budget crisis grows beyond just California…

Time is running out for the legislatures in Arizona, California, Indiana, Mississippi and Pennsylvania to solve budget gaps.

The last time Indiana missed its deadline for passing a budget and had to shut down the government was during the Civil War.

But on Monday, as lawmakers raced to hammer out an agreement over school funding, state agencies began preparing 31,000 workers to be temporarily out of a job. Republican Gov. Mitch Daniels has warned residents that most of the state’s services — including its parks, the Bureau of Motor Vehicles and state-regulated casinos — would be shuttered unless a budget is passed today.

Indiana is one of five states — along with Arizona, California, Mississippi and Pennsylvania — bracing for possible shutdowns this week as time runs out for lawmakers to close billion-dollar gaps in their fiscal 2010 budgets.

Of the 46 states whose fiscal year ends today, 32 did not have budgets passed and approved by their governors as of Monday afternoon, according to the National Conference of State Legislatures.[...]

“It’s a lot of states that are coming down to the wire,” Haggerty said. “It’s far more than we’ve seen in the past, and it’s because of the state of the economy.”[...]

“What’s different now is that the recession has eroded tax revenues across the country,” Haggerty said. Collectively, he said, states are wrestling with budget deficits totaling $121 billion.

In California, state finance officials will begin issuing IOUs on Thursday if lawmakers and the governor cannot agree on a way to close a $24-billion shortfall. The IOUs would go to local governments, vendors, taxpayers and college students receiving state financial aid. California has issued such IOUs only one other time — in 1992 — since the Great Depression.

In Arizona, which has never missed its constitutional budget deadline, officials are battling over how to resolve a $3-billion gap.[...] (source: LA Times)

Watch out for increased taxes, cuts in state services, and additional layoffs.