Those IOUs Are Like SOS Signals : Is California facing a repeat of 1992 debacle?

On the eve of California’s new fiscal year, another budget crisis looms. Unless it is resolved in time, the state faces the grim prospect of repeating the debacle of 1992: having to issue IOUs to pay state bills. Using scrip just once caused financial havoc; to do so again would court disaster, spooking Wall Street when California needs a record $7 billion in short-term financing.

More IOUs would increase the fear and loathing already growing within investors contemplating the state’s budgetary uncertainties. Avoiding another spectacle of fiscal and political irresponsibility clearly is in California’s long-term interest.

Crucial to Wall Street’s assessment of state accountability is whether Sacramento provides a standby plan in the budget to ensure that money is available to pay back what is borrowed.

The Legislature currently is struggling to come to some agreement on Gov. Pete Wilson’s proposed two-year, $57.3-billion budget, which includes a wide range of spending cuts. The lawmakers and Wilson have to work out a plan that would trigger additional, automatic budget cuts if the state’s fiscal condition worsened after a budget was adopted.

That standby plan is central to the state’s borrowing of the $7 billion in short-term money. To assure investors that the debt will be repaid, California is trying to buy credit insurance from a group of banks. The banks, in turn, are seeking assurance of the state’s ability to make good on its obligation.

A standby plan may help get California through the current crisis but could create bigger long-term problems should fiscal conditions trigger more spending cuts. Much of the budget problem has to do with paying for the $3-billion deficit accumulated over the last three years. The state keeps borrowing to pay loans on the deficit, draining the general fund.

It is unrealistic to expect the deficit to be paid off within two years, especially with a budget that relies on federal funds--$2.8 billion to reimburse the state for costs associated with illegal immigrants. There is little chance of that much federal money appearing.

Other states have faced similar deficits and found long-term solutions separate from their state budgets. Massachusetts and Connecticut, for example, have issued bonds dedicated to paying off deficits. California operates under legal constraints that would make it difficult to issue similar bonds without voter approval, but it is noteworthy that Louisiana and New York have created new agencies to help fund their deficits. Similar bold alternative solutions must be explored to find ways for California to pay down its deficit. The IOU route must be avoided at all costs.