State stands to forfeit $3 billion in possible cuts

Meanwhile, Chiang, who acts as the state's banker, has scheduled a meeting for Thursday morning of a state board that will determine what interest rate the state will pay on the $3 billion a month in IOUs it will begin issuing to contractors and some of California's neediest citizens, including the elderly, the disabled and the poor. California last issued IOUs in 1992.

Doing so again could have serious repercussions. According to Treasurer Bill Lockyer, the decline in the state's credit rating that is likely to follow IOUs -- as it did 17 years ago -- would cost the state $3.4 billion in higher interest rates over 30 years, adjusted for inflation.

Wall Street rating agencies have already warned that they are weighing downgrades to the state's credit, which would probably take years to recover, Lockyer's aides said.

So far, no banks have formally committed to honoring the IOUs, said Chiang's spokeswoman, Hallye Jordan. At least one financial institution, the Golden 1 Credit Union, said Tuesday that it plans to accept the state's IOUs from its 710,000 members, some of whom are state contractors.

The governor and legislators can avert the IOUs if they reach a budget deal before they are issued Thursday. But once they are issued, those who receive them will have to cash them with banks that may accept them, or wait until the IOUs come due Oct. 1, Jordan said.

As state leaders searched for a resolution Tuesday, there had been some signs of compromise. But they were fragile.

Democratic lawmakers signaled a willingness to reverse their opposition to Schwarzenegger's plan for borrowing $2 billion in property tax revenues from cities and counties. The idea had angered local officials, and the governor had backed off but apparently embraced it again.

Lawmakers were also discussing some of Schwarzenegger's proposals to curb the growth in Medi-Cal, the state's health insurance program for the poor; to tighten enrollment procedures for food stamps and welfare; and to crack down on fraud and reduce services in the state's multibillion-dollar in-home healthcare program.

Speaking to reporters outside his office, Schwarzenegger blamed legislators for wasting time deliberating over budget solutions, such as tax increases, that were not acceptable to him, but he said that the dynamics appeared to have shifted.