UPDATE 3-California nears insolvency amid budget woes - gov

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SAN FRANCISCO, Jan 15 (Reuters) - California Gov. Arnold Schwarzenegger said on Thursday the state “faces insolvency within weeks” and that he will put new policies on hold until there is a deal with lawmakers to close the budget gap, which will top $40 billion over the current and next fiscal year.

“It doesn’t make any sense to talk about education, infrastructure, water, health care reform and all these things when we have this huge budget deficit,” Schwarzenegger said in his annual state of the state speech.

The speech stood in sharp contrast to his previous state of the state addresses. It was short, blunt and focused on the urgent task of balancing the books of the most populous U.S. state and nation’s biggest issuer of public debt.

In prior years he used the address to propose ambitious plans to overhaul the state government and to call on lawmakers to join him in rallying voter support for significant spending to improve and expand California’s public works.

But now California faces a recession-driven decline in revenues pushing its current budget into a deep deficit and opening another massive shortfall in its next budget.

The housing slump’s ripple effects have finally spread across California’s economy and the mortgage market turmoil that put Wall Street on its heels is slashing into the state’s revenues. California relies heavily on personal income taxes so its coffers swell in good times and run thin in lean times.

The Republican governor and Democrat-led legislature are at adds over how to fill the current year’s budget shortfall and are poised for a struggle to balance the budget for the state’s next fiscal year, which begins in July.

“The reality is that our state is incapacitated until we resolve the budget crisis,” Schwarzenegger said.

“California is in a state of emergency,” he added. “Addressing this emergency is the first and greatest thing we must do for the people. The $42 billion deficit is a rock upon our chest and we cannot breathe until we get it off.”


His speech came a day after the state Legislative Analyst’s Office, which acts as a budget watchdog, issued a report warning that at some point next month the state government will be out of cash if officials do not balance the current budget.

“Some time by the end of February the cash cushion would likely be depleted without any corrective action,” said Jason Dickerson, a budget analyst with the office.

Vendors owed money may get notes promising payment in the future but investors holding California debt should expect timely payments, Dickerson said.

“By all accounts, debt payments appear to be safe in the coming months,” Dickerson said. “All state officials are unified in believing that debt service is a very high state priority for the limited cash that is available.”

By contrast, California’s credit rating is at risk the longer its immediate and structural budget troubles press on.

Wall Street credit rating agencies have long demanded state officials find a way to keep the state’s books balanced, either with new revenues, spending cuts or both.

State officials have, however, routinely engaged in drawn-out partisan battles over budget plans that also have failed to address the financial problems behind the state’s so-called “structural” budget deficit.

“The ongoing structural deficit has just been pushed from last year to this year,” said Steven Zimmermann, a managing director for Standard & Poor’s Ratings Services.

S&P last month warned of a possible downgrade on California’s general obligation debt, which is backed by the state’s general fund, because of the state’s dwindling cash and falling revenues. S&P currently rates the debt “A+.” If the rating is cut, California faces higher borrowing costs.

“There is no question that we have a negative credit watch on the state’s rating so we’re looking very closely for any progress being made on the state’s deficit,” Zimmermann said. “The longer they wait, the bigger the hole.” (Additional reporting by Jenny O’Mara in Sacramento; Writing by Jim Christie in San Francisco; Editing by James Dalgleish)