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California: Can I Pay You in IOUs?

The Golden State may finally be ready to pay small businesses back the IOUs they issued for services.
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Last week, after revising their budget, cash-strapped California officials say they have found enough money to stop issuing IOUs on September 4 and allow creditors to redeem theirs after that date. In July, the Golden State began issuing IOUs --individual registered warrants-- to hundreds of thousands of creditors, including small businesses. The state, struggling under the weight of the recession, has amassed a $2.8-billion cash deficit  and, according to State Controller John Chiang, could no longer pay back its debts without running out of its cash reserves.

"The State of California owes a debt of gratitude to the thousands of individuals and businesses that were forced to bear the brunt of the State's chronic fiscal mismanagement," Chiang said in a statement. "Along with short-term loans that are routinely obtained in the fall, this spending plan should provide sufficient cash to meet all of California's payment obligations through the fiscal year."

The IOUs, which were issued at an annual interest rate of 3.75 percent, were scheduled to mature on Oct. 2. But new cash projections will allow for an earlier maturation date. Chiang announced that the state will need to borrow $10.5 billion to cover California's fiscal needs for the fiscal year. The state's Treasurer has guaranteed an interim $1.5 billion loan by the end of this week to cover the IOUs.

In the meantime, small and big business alike are peeved that California can't pay it's debts. "If you are a big state, you operate on good faith," says Sasha Abramsky, a senior fellow at Demos, a New York-based public policy and advocacy organization. "California started issuing IOUs in July -- that's three or four months for a small business without constant cash flow and that can be devastating."

Although Chiang is trying to advance the redemption date to September 4, Abramsky believes the damage is already done. "They broke a bond of trust," he said, adding, "when they started issuing script instead of currency, they undermined their credibility and the incentive to do business disappeared." On one level, it will be increasingly more difficult for the state to attract future vendors, much less assure them of a timely payment, he says.

Many of California's critics have berated the state for issuing IOUs for the second time in under 20 years, but others believe California can use the registered warrants to stimulate the state's credit.

"I think they should use IOUs," says Ellen Brown, a former business litigation attorney and author 11 books, of which the most recent, The Web of Doubt, proposes how California could turn its IOUs into dollars. "I think they should leave them out there and accept them in payment of taxes, augment the currency."

Brown adds that California should create its own state bank modeled after North Dakota, one of two states (the other is Montana) meeting its budget and creating a cash surplus. Although Governor Arnold Schwarzenegger has already rebuffed the idea, Brown believes it is the only way to reinstate trust and create a "good sound currency."

The State Controller in his statement last week admitted that the IOU distribution was "a shameful chapter in the State's history," and acknowledged that the fiscal challenges are not even close to being resolved. "I urge the Governor and Legislature to continue their efforts to fix the State's structural budget deficit and ensure we are never again forced to issue IOUs or delay payments to California families and small businesses."

Last updated: Aug 25, 2009




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