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A big IOU

What happens when the largest state economy in the country can't pay bills?

Associated Press/Photo by Rich Pedroncelli

A big IOU

SAN DIEGO-The state of California owes Gloria Freeman, president of Staff USA in Rocklin, Calif., payments that total six figures and are six months past due. Freeman, whose company provides emergency medical staffing, has had to lay off about 10 percent of her workforce due to the state's inability to meet its obligations.

The Golden State treasury is catastrophically short of gold. In the midst of a budget deadlock in the legislature, the state this month began issuing "registered warrants," essentially IOUs, as payment for debts to some 14,000 private contractors and social service agencies. Also, thousands of Californians who were expecting state income tax refund checks are finding registered warrants in their mailboxes instead.

In total, the state, which constitutes the world's eighth largest economy, has issued some 100,000 IOUs worth nearly $355 million, and is expected to use the warrants to pay $2.9 billion in debt in the month of July alone.

The registered warrants carry an interest rate of 3.75 percent - but only if recipients wait until Oct. 2 to redeem them. Many folks can't hold out that long. Freeman said she has not yet received any registered warrants in payment, and when she does it will be too late to cash them: Most banks have announced in the last week that they will not accept the IOUs from business customers.

Three major financial institutions - Wells Fargo, Bank of America, and JP Morgan Chase - stopped accepting the registered warrants for individuals last week. On July 13, U.S. Bancorp joined the list. At Wells Fargo automatic teller machines across the state, a message warns that the bank will not accept IOU deposits and offers a telephone number for help. Some institutions are working with cash-strapped customers to give them home equity loans and lines of credit. The drawback: California taxpayers are paying interest to use their own money because the state can't pay its bills.

The fault lies in Sacramento, where lawmakers cannot agree on a budget plan for 2010. Democrats favor raising taxes to balance the budget while Republicans favor cutting programs. Two years ago, Gov. Arnold Schwarzenegger teamed with statehouse Democrats and some Republicans to implement a two-year tax increase to meet budget shortfalls. In May 2009, California voters, already some of the most highly taxed in the nation, soundly defeated a ballot initiative that would have extended those tax increases. Nothing if not a populist, Schwarzenegger has now switched fiscal horses and is riding with the people. Statehouse Democrats hold a huge majority, but not enough to muster the two-thirds vote necessary to raise taxes. Even if they did, Schwarzenegger has pledged that he will not sign a budget deal that raises taxes or shuffles the state's fiscal woes down the road.

"The road stops here," the governor says to the camera in a television ad just released.

State lawmakers must balance the budget by the end of August to avoid defaulting on payments to state pension funds and paychecks to government employees. If the governor stands firm against raising taxes, it is likely that Democrats will see some pet programs gutted.

State Controller John Chiang on July 10 endorsed a measure to require California to accept its own IOUs as payment for obligations owed to the state. "This is a huge boost for this critical piece of legislation that will provide relief to thousands of Californians who are being asked to pay a steep price for a problem they did not create," said the bill's sponsor, Republican Assemblyman Joel Anderson, in a statement.

Meanwhile, some business owners are rethinking their relationship with California. "After this, we may not do business with the state anymore," said Staff USA's Gloria Freeman. "It's like doing business with someone who never pays you."

Lynn Vincent

Lynn is executive editor of WORLD Magazine and producer/host of the true crime podcast Lawless. She is the New York Times best-selling author or co-author of a dozen nonfiction books, including Same Kind of Different As Me and Indianapolis. Lynn lives in the mountains east of San Diego, Calif.

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