Rushed effort to prevent California county bankruptcy

SAN FRANCISCO (Reuters) - California officials are scrambling to find a way to bolster the finances of a rural, remote county to stop it from declaring bankruptcy.

It's a touchy subject in the state capital of Sacramento, where California's notoriously dysfunctional budget process is on parade again with Republican Governor Arnold Schwarzenegger and the Democrat-led legislature facing the task of crafting a state budget, now weeks overdue, that closes a $19 billion deficit.

Modoc County only needs about $15 million to bolster its finances in the near term. The amount is not what concerns state officials. Instead they're uncertain just how the state can provide the money. If it does not, they're concerned headlines will link the state's name to the term bankruptcy.

California officials already have their hands full calming concerns about the state government -- its credit rating hovers just a few notches above "junk" status. Two years ago the city of Vallejo became the state's first sizable city to file for Chapter 9 bankruptcy, and state officials do not want added concerns on their plate about local finances.

At the time, some analysts predicted Vallejo was on the leading edge of a trend in which local governments in California struggling with gaping deficits brought on by soaring payroll and pension costs as revenue tumbled would opt to beg for mercy from bankruptcy judges.

That hasn't happened. But as Modoc County now shows, there are other financial snares in the books of local governments capable of pushing them to and potentially over the brink and to plead for state help.

Modoc County needs help fast, said San Francisco lawyer Michael Sweet, who is helping the county sort out its options, including a Chapter 9 bankruptcy filing.

Sweet said county officials need to make a decision on that dramatic step soon. "They may not be able to go past July 31," he said. "Everyone is focused on that date right now."

MISMANAGED HEALTH CARE

Roughly 9,500 people live in Modoc County, barely changed over the last 50 years, and government -- local, state and federal -- is its largest employer. The county's biggest provider of government work is the county hospital, which is effectively a cancer on the county's finances.

Modoc County's books are a mess following a decade of questionable borrowing from restricted and other funds to cover operating deficits at the hospital, county officials said in an emergency loan request to Lockyer's office.

"Budgetary control was lacking and the management lines within the County were dysfunctional," the document said, adding the county needs $14.8 million to repay funds used over the years to keep its hospital open as well as to provide it and other county programs with urgently needed cash.

The county treasury has funds but the new county auditor, elected in June, is reluctant to pay bills as they have been in the past, citing legal concerns. That puts near-term payments, including paychecks for county workers, in doubt.

"The issue is if we can make payroll," Auditor Darcy Larkin said. "As in next week."

Larkin is also addressing questions in audits raised by the state controller. The answers won't be pretty but could help advance the county's request for a state rescue, she said: "We already know the accounting wasn't done properly."

Modoc County cannot bond its way out of its problems. Audit problems are an obstacle to a bond rating, the first step for the county to sell bonds to raise funds, said Amy Doppelt, a managing director Fitch Ratings.

Doppelt met with county officials to review the county's finances and said they have to be viewed skeptically, noting concern about the audits.

State Treasurer Bill Lockyer's office believes it has the legal authority to craft a rescue package for Modoc County, said office spokesman Tom Dresslar.

"It looks like we've worked through some legal thickets and we're now going to explore short-term and long-term financial relief that would get it through its fiscal straits and avoid bankruptcy," Dresslar said.

But he added that, "It's far from cooked," noting the fate of a rescue plan rides on Modoc County's ability to assure it can pay back any state funds offered to it.