Cash-strapped states up against budget deadlines

SAN FRANCISCO (Reuters) - California prepared on Tuesday to resort to issuing IOUs as the giant but cash-strapped U.S. state struggled to approve a new budget in time for the new fiscal year that begins on Wednesday.

The IOUs, which are notes promising payment to vendors and local agencies, or shutting down some public services, are among measures that California and other states may have to rely on as they contend with staggering budget gaps caused by the U.S. recession.

Several U.S. states are due to start their fiscal years on July 1 with budget talks at an impasse. California, the most populous state, is especially hard hit.

The Golden State, hit by a leap in unemployment and a crash in property values, is suffering its worst tax revenue fall since the Great Depression and faces a $24.3 billion budget deficit.

"It's been a sort of perfect storm, of a very deep recession hitting us and exposing the weakness of depending on revenue sources sensitive to economic cycles," labor lobbyist Barry Broad said.

Fixing the massive budget gap "is going to require pain. That's the only way out of it," added Jack Pitney, a professor of government at Claremont McKenna College.

California Governor Arnold Schwarzenegger insists on deep spending cuts. But Democrats who run the Legislature want tax increases that Schwarzenegger and fellow Republicans oppose.

GIVING WALL STREET HEARTBURN

Budget talks have ground to a stalemate, forcing State Controller John Chiang to prepare IOUs to be mailed on Thursday.

They would preserve dwindling cash for payments to schools and, just as important since California needs to sell short-term debt, for cash-flow purposes -- once it has a budget agreement.

Chiang plans to issue $3.36 billion in IOUs in July to help California maintain $10.9 billion in normal cash payments during the month, including payments to bondholders.

"The general obligation bonds will be paid," Chiang told Reuters. "California has never defaulted on its debt obligation and we don't plan to do so."

California's budget woes are making Wall Street nervous.

Fitch Ratings last week downgraded its rating on the state's general obligation debt and warned it may lower the rating again, citing the state's fiscal and economic stress. The agency cut California's rating by one notch to A-minus, placing it four notches above speculative, or "junk" status, and making it the lowest rating of any U.S. state.

Standard & Poor's Ratings Services and Moody's Investors Service have also warned there may be downgrades of California's general obligation debt. Moody's has warned the state could see a multi-notch downgrade of its A2 rating. S&P rates $57 billion of the state's outstanding general obligation bonds A.

A MUDDLE IN THE MIDWEST

As California officials readied their IOUs, Ohio Governor Ted Strickland on Tuesday signed a seven-day interim spending plan that buys lawmakers more time to craft a two-year budget.

"It is troubling that Senate Republicans are still refusing to say what they would do to fill the budget gap. Because of this, I have no other option but to sign a temporary budget that only delays the inevitable hard choices before us," Strickland, a Democrat, said in a statement.

Meanwhile, Indiana appeared to be on course to avert a government shutdown at midnight. A vote on a compromise budget was heading for a vote on Tuesday, according to John Schorg, a spokesman for Democrats who control the House.

Republican Governor Mitch Daniels has said safety services, such as state police and prisons, will continue to operate should there be a shutdown, while other services would stop.

Illinois lawmakers could send Governor Pat Quinn legislation to sell $2.23 billion of shorter-term general obligation bonds to ease spending cuts in a budget they passed late last month. Proceeds from the bonds would fund part of a fiscal 2010 pension payment, freeing up money in the budget.

But Quinn, who has claimed the Legislature's budget has a $9.2 billion shortfall, appeared to be holding out for a balanced spending plan to avoid drastic cuts in social services spending. He has been pushing for an income tax increase.

Pennsylvania's lawmakers were stuck on Governor Edward Rendell's plan to raise the income tax rate, possibly pushing negotiations past the midnight deadline.

(Additional reporting by Karen Pierog in Chicago and Jon Hurdle in Philadelphia; Editing by Jan Paschal)