Hope for California budget deal as "IOUs" planned

SAN FRANCISCO (Reuters) - Top California lawmakers raised hope on Thursday that an elusive budget deal could be at hand, as officials began issuing billions of dollars in "IOUs" to avoid a cash crisis on the second day of a new fiscal year without an agreement to balance the state's books.

"I think there is at least a 50-50 chance that we'll find a solution that is acceptable to all parties within a week," Assembly Republican Leader Sam Blakeslee said after the state Senate's top Democrat said Democrats would no longer hold out for tax increases as part of a budget agreement.

California faces a financial stranglehold after lawmakers failed to balance the budget by the start of the state's new fiscal year on Wednesday, leaving a $26.3 billion deficit and prompting Republican Governor Arnold Schwarzenegger to declare a fiscal emergency.

He minced no words on Thursday in lambasting lawmakers for their failure.

"In four weeks, in the last four weeks, instead of negotiating and coming to a budget agreement, they decided to debate and to debate and to have hearings and more debates and more hearings and finger-pointing and assigning blame. At the end of the day, they haven't accomplished anything," Schwarzenegger said at a press conference in Los Angeles.

Senate President Pro Tem Darrell Steinberg said state leaders need to cool their heated rhetoric of recent days and that he would work with other top lawmakers over the weekend to narrow differences over balancing the budget.

"In my view we're making significant progress," Steinberg told reporters in the state capital of Sacramento. "It's time that we get this done."

Democrats who control the legislature cannot pass a budget on their own. They agree with Republicans that deep spending cuts are needed to close the budget gap but have pressed for tax increases, which Republican lawmakers and Schwarzenegger have opposed.

With the state preparing IOUs and anxiety mounting on Wall Street over the budget impasse, Steinberg said Democrats would back off on demands for tax hikes.

Blakeslee hailed that as a major breakthrough. "With that off the table, more meaningful progress will happen," he told Reuters in a telephone interview.

California is experiencing a severe revenue slump because of the recession, rising unemployment -- which hit 11.5 percent in May -- and the lengthy housing downturn.

NO CHECKS IN THE MAIL

Under the plan to issue IOUs in lieu of paying some bills immediately, finance officials in Sacramento approved paying interest on the IOUs at a rate of 3.75 percent. The state agreed to redeem the IOUs, technically registered warrants, beginning on October 2.

Controller John Chiang plans to issue $3.36 billion (2.05 billion pounds) in IOUs this month to free cash for $10.9 billion for priority bills, including money owed to investors holding state debt.

"IOUs are a sign that the state is being fiscally mismanaged," Chiang said. "That clearly creates implications for further downgrades of California credit ratings."

The first tranche of IOUs will go mainly to taxpayers who are owed tax refunds. "We anticipate printing about 28,742 registered warrants today worth about $53.3 million," said Chiang spokesman Jacob Roper.

Companies doing business with the state, local agencies and individuals on financial aid such as the disabled, elderly and college students could be in line for the IOUs, raising uncertainty amid already worrisome economic conditions.

"We don't really know exactly what's going to come out of this," said Art McCoy, owner of French Fry Xpress, a Milpitas, California firm that delivers food products to state prisons.

Bank of America and Wells Fargo have said they will accept the warrants.

REASSURING WALL STREET

California's finance officials are aiming to reassure the municipal debt market in anticipation of having to sell up to $9 billion in short-term debt after a budget is approved.

But Wall Street has its doubts. "Absent a credible budget revision package, we believe the state may suffer insufficient investor confidence in its finances to successfully place such an offering," rating agency Standard & Poor's said on Wednesday.

S&P also warned that if California's budget is not settled soon, the state's A-credit rating, already the lowest of any of the 50 states, is at risk of falling.

State Treasurer Bill Lockyer's office now doubts it will be able to sell short-term revenue anticipation notes (RANs) for state cash-flow needs as it had planned because of the budget turmoil. Revenue anticipation warrants remain an option, but would be more expensive for the state.

"We're exploring a variety of avenues to increase the potential market for our short-term cash-flow borrowing," Lockyer spokesman Tom Dresslar said. "The way the fiscal picture looks at this time, RANs do not look likely."

(Additional reporting by Marianne Russ in Sacramento, California; Editing by Leslie Adler and Eric Walsh)