California closes budget gap, worries about next

California Governor Arnold Schwarzenegger speaks during a news conference in San Francisco, California July 3, 2009.

SACRAMENTO, California (Reuters) - California's legislature on Friday approved a $24 billion package of bills to close a deficit that had driven the state to the edge of financial ruin, although Governor Arnold Schwarzenegger said the weak economy could create new budget holes.

Forced to pay with IOUs as coffers ran nearly dry, battling record 11.6 percent unemployment and a lingering housing crisis, the so-called Golden State is still struggling, but the agreement should let it return to debt markets.

Exhausted legislators in the state Assembly passed their package late on Friday after working through the night. Assembly members dropped a scheme to allow oil drilling and other measures in the Senate plan, but Schwarzenegger said he could make up lost revenue with line-item cuts.

Education and funding for local governments are high on the list of cuts by the most populous U.S. state, which has the eighth-largest economy in the world

Schwarzenegger's administration had calculated the budget deficit at $26 billion, including a $2 billion reserve sought by the governor.

The governor congratulated legislators but was hardly jubilant, conceding that additional cuts may be necessary because of the weak economy. "We're still in troubled waters," he told reporters after the votes.

Standard & Poor's, one of the three credit agencies that has lowered California's rating near "junk" levels, will look to see how many one-time measures were included in the final bills passed.

"It's definitely a necessary step but it's not clear if it's a sufficient one to improve our credit concerns over the state," said S&P's analyst Gabriel Petek.

COURT CHALLENGES TO BILLS

California's budget also faces threats from opponents of the bills before the legislature. Unions for state workers have said they would challenge the bills in court because they contain more than $15 billion in spending cuts.

Under the legislation, public schools would lose nearly $6 billion, higher education about $3 billion and prisons more than $1 billion. Social services would lose more than $1 billion and health programs would lose $2 billion.

In addition, furloughs will continue for state workers for three days a month, cutting their pay by 15 percent.

The legislation also provides for redirecting billions of dollars from local governments, an idea opposed by many lawmakers. City and county officials say they will challenge it in court.

The League of California Cities said in a statement after the votes that the budget contains a "clearly unconstitutional diversion" of local redevelopment funds.

TERMINATOR SAYS 'YES'

Former Hollywood icon Schwarzenegger has been wrangling with legislators for months.

"This budget is an acceptable budget to me," he said on Friday, adding that he would build a "responsible reserve" through line-item budget cuts.

The Assembly package did not include a more than $900 million reserve, $100 million in offshore-drilling revenue and a transfer to state coffers of more than $1 billion in local fuel taxes that were part of the Senate plan.

Despite relief at finishing the job, legislators' moods through more than 24 hours of debate and vote was somber.

"I have no illusions about the possibility that we may be back" to readdress the deficit, said state Senate President Darrell Steinberg in the middle of the night.

(Reporting by Jim Christie; Additional reporting by Alexandria Sage; Writing by Peter Henderson; Editing by Richard Chang, Gary Hill)