California Crisis Deepens: Are Other States To Follow?

Today is the day Californians begin to personally feel the pain of the state's massive budget gap. As Gov. Arnold Schwarzenegger and top legislative leaders continue to meet behind closed doors to hammer out a plan covering the current $16 billion gap—projected to grow to $42 billion by June, 2010—the state controller is delaying $3.5 billion in payments to conserve cash.

A self-imposed deadline for coming up with a budget deal by this weekend came and went, with no word on how close all sides are. Democrats, who control the legislature, have proposed a package of massive cuts and massive tax hikes. Republicans, which have enough votes to

torpedo any budget deal, will only agree to the tax hikes if there is a hard spending cap to prevent future crises. And the governor wants to make sure the resulting package has enough stimulus programs to spur jobs creation projects. This includes easing some environmental review requirements, which Democrats have balked at.

California is hardly alone. Wisconsin is facing its largest shortfall in history, $5.7 billion, and the Wisconsin State Journal says the state's rainy day fund only has enough cash to run operations a day and a half.

Kentucky lawmakers have been meeting for weeks to figure out how to close a budget gap nearing half a billion dollars. Arizona just cut a deal on handling its $2 billion deficit, the worst situation the state has been in since 1929. But Alabama, Florida, Rhode Island, and Utah all have budget gaps which equal more than 10 percent of their general fund.

And New York City, which nearly went famously bankrupt in the 1970s, now is struggling to close a $4 billion gap. That's $4 billion for New York City. Not the state.

They all pale, though, in the shadow of California's gaping chasm of debt. The Golden State is still taking in plenty of money daily from taxes, but the controller says the state needs to keep a cash cushion of $2.5 billion, and that has dwindled to zero.

So Controller John Chiang has laid out his spending plans for February. The state's constitution mandates that the first dollars the state takes in go to education, followed by debt payments. Of the $6.5 billion California will spend this month, $4 billion will go to education alone. The rest will go to bond holders, Medi-Cal, and payroll (minus mandatory unpaid furloughs which start Friday). But $3.5 billion in payments will be delayed for 30 days. Most of that amount is for tax refunds, but about $1 billion is for social services for the state's needy, and $500 million will be delayed to businesses who provide goods and services to the state. What's more, the controller says he may ask for another 30-day delay in March, when cash reserves will again go to zero, barring a budget deal.

Those denied payments will not be receiving IOUs in lieu of checks, despite reports to the contrary. Controller Chiang's office tells CNBC that IOU's "are a last resort."
On his Web site, he explains why:

"There are no assurances at this time that all financial institutions will accept registered warrants (IOUs) and it is unlikely that any registered warrants issued will be redeemed by the state for several months. Additionally, registered warrants likely will complicate the cash flow borrowing which the State will be required to undertake in July. As the Governor and Legislature work to fix our budget, they are expected to need short-term or cash-flow borrowing from the credit markets to make any new budget work."

Also today, employee unions are going to court to appeal a judge's ruling last week giving Gov. Schwarzenegger the authority to furlough most of the state's 238,000 workers two days a month. And local governments are scrambling to try to find ways to cover funds the state can't pay for services. This as the state's unemployment rate has rocketed to 9.3 percent, and it's No. 1 industry—agriculture—suffers through the worst drought in decades. For more stories from CNBC, go to

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