In California, grandma, the blind get IOUs; politicians get USD

As California is set to begin issuing IOUs instead of cash due to a budget crisis, Felix Salmon has a chart explaining who will keep getting paid in cash, and who will have to accept paper promises. Sadly, but not surprisingly, politicians and judges will continue to get greenbacks, while the poor, elderly, and disabled will have to learn to deal with California's new "currency."

Estimates put the total IOU payments in July at $3.35 billion, with the majority going to the Department of Social Services for assisting the aged, blind, disabled, and basic family needs. Vendors and those helping the developmentally disabled will also be major recipients of the IOUs. There is also $10.9 billion in additional July spending that is mandated to be paid in cash by a combination of Constitutional, Court, and Federal laws (including the salaries of legislators and judges), that the legislators haven't yet found funding for.

California Governor Arnold Schwarzenegger has stated that he will not accept any partial solutions to the state's $24 billion budget deficit, having vetoed measures that sought to temporarily delay the current measures. In a statement about the fiscal emergency, he said, "solving the entire deficit remains my first and only priority, and I will not rest until we get it done. I will not be a part of pushing this crisis down the road - the road stops here."

This day of fiscal reckoning has had decades of mis-managed budgeting leading up to it. As Lita Epstein notes, going back to the 1970s, "Republicans have steadily cut taxes, while Democrats have tried to minimize cuts to the social and education programs in the state. Instead of reaching a compromise on the matter, the state has funded its shortfall by issuing bonds."

Now, with California hard-hit by falling revenues from the recession and the bursting of its massive real estate bubble, the borrowing binge looks set to come to an end. The limited historical precedent for such actions complicates matters for the people and institutions suddenly faced with handling billions of dollars in IOU payments.

Bank of America (BAC) has stated that they will accept the IOUs from California "to support our customers, while giving the state legislature additional time to pass a budget." Wells Fargo (WFC) has also said they will accept the notes for a limited time, "to help our customers who are not at fault and with the expectation that the Legislature and Governor will complete the budget within days. We join all Californians in urging our Legislature and our Governor to take the appropriate steps as soon as possible to resolve this budget crisis." If banks decide to accept the notes, then they will be exposed to credit risk from the State of California in the event of a default.

How the state will end up resolving the issue is still an open question, but the message it is sending is clear -- lacking the federal government's option of trying to print its way out of economic problems, states with poor finances are at risk of disastrous budget outcomes that will likely couple significant cuts in services with large increases in taxes. Barring drastic action on the part of state legislators across the country to bring spending in-line with tax revenues, look for new levels of stress to become a new trait of the state and municipality budgeting process.

James Cullen also edits and writes at CollegeAnalysts.com.

Update: I spoke with Lizelda Lopez, Deputy Director of Public Affairs for the California Department of Social Services. She emphasized that end recipients of CalWORKs would still receive checks; it was the agency who is being given "IOUs" - and that the February budget had already made it clear the state was not going to be making payments in July or August, but at a later date. Likewise, the Social Security Administration will still send full supplemental checks to recipients, and the State of California will pay that back with interest sometime in the future.


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