The State of California currently faces an unprecedented $20 billion cash shortage between this July and October and has requested that the federal government extend its “Troubled Asset Relief Program” (TARP) assistance to the state to allow the state to draw down $20 billion in short-term borrowing from private investors.
State Treasurer Bill Lockyer and the Legislative Analyst say this amount of borrowing will be next to impossible, absent intervention by the federal government, due to the size of the amount needed, the state’s poor credit rating, and the significant weakness in credit markets.
On May 13, 2009, Treasurer Lockyer wrote a letter to U.S. Secretary of the Treasury Timothy Geithner asking the federal government to extend its “Troubled Asset Relief Program” (TARP) assistance to the State of California and other financially strapped states and local governments.
LAO Says “Time is of the Essence”
The Legislative Analyst says “time is of the essence” and “the greatest near-term threat to state cash flows would be an inability by state leaders to quickly address California’s budget imbalance,” according to a recent report. The failure of Propositions 1C, 1D, and 1E increased the state’s budget deficit by an additional $5.8 billion, from $15.4 billion to $21.3 billion for the 2009-10 budget year, setting up a high stakes budget showdown in the coming weeks.
The budget package passed by the Legislature in February helped close a $40 billion shortfall projected for 2009-10. Lower than expected tax revenues, higher than projected expenditures, and the failure of the special election ballot package led to the re-emergence of a $21.3 billion budget gap.
“If there were to be a prolonged impasse, the Treasurer and Controller could be prevented from borrowing sufficient funds to allow the state to pay its bills on time,” states the Legislative Analyst.
The Legislature faced similar warnings in February and last summer but the deep partisan divide over enacting tax increases and spending reductions led to long budget standoffs despite early and repeated warnings by the Treasurer, Controller and Legislative Analyst. Passage of a California state budget requires a 2/3 vote of the Legislature, which means that the Democratic Legislative leadership must find three Republican votes in both the State Assembly and State Senate to enact a budget.
The events of last February and last September suggest that convincing Republicans to vote for additional tax revenues will not be an easy task. The six Republicans who voted for tax increases included in the February budget agreement have faced a huge backlash from the Republican Party and anti-tax activists. State Republican lawmakers have since voted to remove both Republican leaders who negotiated the February deal and Republican activists are busy pursuing recalls for at least two of the Republican lawmakers who voted for the February budget.
The alternative is deep spending reductions to education, health and human services programs, and other vital state services that the Democratic leadership has repeatedly rejected in the past.
The Legislative Analyst has advised the Legislature to reduce the state’s short-term borrowing need to an amount less than $10 billion for 2009-10 by taking action to reduce state expenditures or increase revenues in order to return the 2009-10 budget to balance or delay or defer scheduled payments to schools, local governments, service providers and other state vendors.
State To Run Out of Cash In July
Controller John Chiang (D) has said that the state will have enough cash to pay its bills through the 2008-09 fiscal year, which ends June 30. However, an analysis by the Legislative Analyst states that California will run out of money by the end of July.
The Department of Finance (DOF) forecasts that the state will have a $6.9 billion cash cushion on June 30, which consists entirely of borrowable special fund resources and no available General Fund resources. The DOF projects that the General Fund is expected to have a monthly cash flow deficit of $7.9 billion in the month of July 2009 alone, which will more than consume all available state cash reserves. Monthly cash flow deficits of varying amounts are projected under the February budget package for every month between July 2009 and November 2009.
Such deficits would force the state Controller to either borrow externally or delay state payments, as he did in February and last summer, to school districts, counties, social service providers, vendors and others who count on state payments for their own livelihoods.
The Legislative Analyst estimates that these five consecutive months of monthly cash flow deficits means that the state will be required to undertake an unprecedented $20 billion in short-term borrowing by October in order to pay all bills on time and maintain a minimum cash cushion.
“California is likely to have difficulty borrowing anywhere close to the needed amounts from the short-term bond markets based on the state government’s own credit,” states a recent report by the Legislative Analyst.
The state commonly undertakes short term borrowing to help smooth cash flow differences over the year because the state tends to spend most of its money early in the fiscal year and take in most of its revenues later in the year. This year the situation is much more dire because the June 30 year-end cash cushion is roughly half of what the state had last year and the state’s cash flow gap has since been exacerbated by a poor economy.
California Treasurer Requests Federal Assistance
State Treasurer Bill Lockyer requested federal loan assistance in a May 13, 2009 letter to U.S. Secretary of the Treasury Timothy Geithner.
“We have developed a structure, described below, to help the State and other governments obtain the short-term funding they need, but cooperation from the banking community and back-up TARP support from the Treasury will be critical to making the proposed transactions successful,” wrote Treasurer Lockyer.
Governments normally issue short-term notes secured by future tax revenues (called Tax and Revenue Anticipation Notes or “TRANs”) to bridge timing imbalances between revenues and expenditures during a fiscal year.
But given California’s weakened financial condition, the state will need to structure a significant portion of its TRANs with credit enhancement provided by letters of credit or standby purchase agreements from banks and other financial institutions in order to gain access to the capital markets. In the event of a default by the state, the bank would make the required payments to investors in exchange for the notes and the state would be legally obligated to repay the banks over time.
“The current credit crisis makes it highly unlikely that the State can induce the banks to provide the required credit support, even at exorbitant rates, without further protection for the banks,” Lockyer wrote.
Treasurer Lockyer proposes that the U.S. Treasury establish a program under TARP that would obligate the U.S. Treasury to purchase defaulted state or local government TRAN notes from the banks in the event of default.
“We are highly confident that such a program would be greeted with enthusiasm by the banking community, which would make available substantial amounts of credit for TRAN borrowings,” Lockyer wrote.
LAO Cautions That Federal Assistance May Not Come Or Could Come With “Strings Attached”
The Legislative Analyst cautions the Legislature from assuming that federal assistance will be available to avert the state’s cash crisis and says that if such assistance does come there will likely be “strings attached” that would limit the discretion of state policymakers.
The LAO suggests that the Legislature do everything in its power to reduce the amount the state needs to borrow in the short-term credit markets to “enhance the ability of the Treasurer and Controller to secure private investment with or without a federal loan guarantee.”
The LAO suggests reducing the state’s medium and long-term structural budget deficit to increase confidence in financial markets.
“In our opinion, the difficult decisions to balance the state’s budget now are preferable to Californians losing some control over the state’s financing and priorities to federal officials for years to come,” concludes an LAO report. The LAO report cites the strings attached to the recent corporate bailouts as well as the federal loan guarantees provided to New York City during the city’s fiscal crisis three decades ago as examples of possible strings the federal government will attach to any agreement it reaches with the state.