California issues IOU's in wake of budget stalemate, banks will accept them until July 10th

It appears that the California budget stalemate between the legislature, and the Governator, is heading into a full-blown, statewide crisis. Or maybe I should say that this entire California budget crisis is heading into the toilet? Either way, the state is now printing out IOU's to pay for its bills. This is from a July 3, 2009 Los Angeles Times story:

Deep in debt and short on cash, California on Thursday churned out its first batch of IOUs in nearly two decades amid grumbles from bankers, growing public outrage and scant progress in negotiations to resolve the state's widening budget deficit.

The state controller's office fired up a pair of printing presses and began rolling out nearly 29,000 IOUs totaling more than $53 million, most of them destined for residents around the state still awaiting income tax refunds. Recipients also include some businesses, pensioners, health clinics, college students and many others who get checks from the state.

"We never thought we would do it again," said Dorothy Cottrill, who manages check disbursement at the state controller's office and still remembers the last time the state spun out IOUs in the lean days of 1992.

The unusual move came hours after a panel of state finance officials set the annual interest rate for the IOUs at 3.75% for banks and other financial institutions willing to accept the vouchers. Some banks, including Bank of America, Citi and Wells Fargo, have agreed to honor the paper, but only until July 10. Many recipients could receive their IOUs after that date.

Those who don't have a bank that will cash the IOUs can redeem them from the state Oct. 2, or sooner if officials settle on a solution to the financial crisis.

Rodney K. Brown, president and chief executive of the California Bankers Assn., said the state's failure to resolve the budget crisis "has placed a tremendous burden on California's citizens, communities and banks."

State officials estimated that without a budget resolution they will have to issue $3.2 billion in IOUs in July and $1.65 billion in August.

State Controller John Chiang said the IOUs "are a sign that the state is being fiscally mismanaged" and a precursor to further credit downgrades for California, already the lowest-rated state on Wall Street.

The IOUs come two days after state Senate Republicans, with the support of Gov. Arnold Schwarzenegger, blocked an eleventh-hour attempt by Democratic leaders to push through budget proposals that would have staved off the IOUs, at least temporarily.

And in the wake of these IOU's being printed, the banks are saying that they will only honor the IOU's until July 10th. From this July 3, 2009 Los Angeles Times story:

Bank of America announced late Wednesday that it would redeem in full the state's IOUs (formally, "registered warrants") from current BofA customers who want to cash them in. But the bank set a cutoff date of July 10.

On Thursday, other big banks including Chase, Wells Fargo & Co. and Union Bank followed BofA's lead, saying they'll cash the IOUs from customers only through July 10.

Some banks, including City National, didn't set a cutoff date, but they didn't preclude doing so at some point. Many credit unions also have agreed to accept the IOUs from customers without setting a time limit, the California Credit Union League said.

The big banks' hardball strategy will create hardships for their customers if no budget deal is struck soon and the state continues to issue IOUs instead of checks. The state set a redemption date of Oct. 2 for the IOUs, although it said it might redeem them before then if it has the cash. Other lenders may step up to buy the IOUs in the interim, but probably at a discount to face value, unlike the big banks' redemption programs.

When asked why it set such a narrow window for customers to cash IOUs, BofA cited the "operational and financial" challenge of accepting them.

In some ways, I'm not surprised that the California budget crisis is going down the toilet. It seems like every year, there is a budget crisis taking place between the legislature and the governor--budget crisis after budget crisis going on for the past couple of decades. Meanwhile, bond proposition after bond proposition is passed every election year by California voters--with no way to pay for these bonds. So in the end, the California budget crisis has grown from a slow burning house fire, to an exploding conflagration, while the firefighters are bickering over how to pay for the water bill. In the end, everything burns to a crisp.