Calif. prepares to issue IOUs instead of checks

July 01, 1992|By San Francisco Chronicle

SACRAMENTO -- Finally broke after two years of red ink, California began printing IOUs that the state plans to distribute instead of checks starting today.

Most financial institutions are expected to cash the IOUs, known as registered warrants, for their existing customers at least for a few days. But bankers warned that they cannot allow the state what amounts to an unlimited line of credit for long.

The problem is that the Democratic-controlled Legislature and Gov. Pete Wilson, a Republican, have not agreed on a budget for the fiscal year beginning today. They are having more trouble than usual because the recession has lowered revenues and the state faces a $10 billion deficit.

State Controller Gray Davis admitted that issuing registered warrants endangers California's credit rating and embarrasses everyone connected with it. Despite the recession, no other state is even considering IOUs.

"All of us in Sacramento will have our reputations tarnished," Mr. Davis said at a news conference held at a state check-printing plant. "I can't imagine this situation dragging on more than two or three days in July."

Mr. Davis said the first batch of 13,000 registered warrants worth $34 million would be mailed out today, mostly refunds of personal income taxes.

It will mark the first time California has distributed IOUs since the Great Depression, except for a few warrants issued in 1982, all of which were repaid the same day.

By July 10, $415 million in IOUs could be issued to employees, vendors, providers of Medi-Cal services and the 58 counties, which use state money for welfare payments. By the end of the month, the total could swell to $2 billion.

California often begins its fiscal year on July 1 without a budget, but in previous summers, the state has been able to borrow from special funds to pay its bills. Internal credit sources have been exhausted over the past two years because the state tapped them to finance general fund deficits. The general fund has a zero cash balance and owes the special funds about $6.5 billion, the controller's office said.

The banks, by acceding to the state's request that they accept the warrants at face value, effectively are lending money to the state with no clear timetable for when they will be repaid.

"While the Legislature and the administration engage in high budgetary theater, banks have been asked to cash instruments which are nothing more than IOUs, advancing billions of dollars to the state," said Larry Kurmel, executive director of the California Bankers Association.

The warrants pay 5 percent annual interest. But Mr. Kurmel said that because of risks and special processing costs, "the banking industry, in fact, will most likely suffer a loss in accepting registered warrants."

By cashing the warrants, the banks could bump against federal ceilings on the amount of money they can lend, Mr. Davis and bankers noted.

Bank of America and Wells Fargo were among the banks that said they would accept the checks. State officials met with Bank of America in a six-hour negotiation Monday to hammer out details, including repayment schedules.

But the state probably will not be able to redeem any of the warrants until a budget is enacted and the state legally can borrow money on the credit markets, Mr. Davis said.

Tax revenues that come in this month will be reserved for payments for debt service and to schools, which are protected by the state Constitution. Even those payments could be in jeopardy if there is no budget by the end of July.

Another consequence is that the state is likely to suffer another decline in its credit rating, which has already been downgraded by the three major rating services since the budget crisis began last year. The state's credit rating ranges from AA to AA-plus, depending on the agency.

One major rating service, Moody's, warned: "The issuance of scrip would represent a critical failure of the state to meet its operating obligations and would likely result in a lowering of the state's general obligation and related ratings."

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