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California begs U.S. Treasury to backstop loans

The state needs to borrow $15 billion to keep paying its bills. With its credit rating in the toilet and former guarantors with troubles of their own, officials say U.S. backing may be the only hope.

May 21, 2009|Evan Halper and Tom Petruno

SACRAMENTO AND LOS ANGELES — First came the banks and insurance companies. Then the auto industry. Now, with California on the verge of financial collapse, state leaders are demanding an unprecedented federal rescue of their own.

They say they need the Obama administration to step in and back billions of dollars in emergency loans. If Washington fails to do so, the state could start running out of cash in July and then would have to stop paying huge amounts of its bills. That, in turn, could set off dangerous ripples throughout the economy, state officials say.

The argument is familiar. Just like AIG and General Motors, California says it is too big to fail.

"A fiscal meltdown by California . . . would surely destabilize the U.S., if not worldwide, financial markets," State Treasurer Bill Lockyer wrote in a May 13 appeal to U.S. Treasury Secretary Timothy Geithner.

Such federal assistance for a state has never been tried before, experts say. The last time the U.S. Treasury acted in any comparable way was during the financial crisis in New York City in the 1970s. And that assistance came with strings attached -- as the recent bailouts of the auto and financial industries have -- with the city government forced to cede some control of its finances.

"We're in uncharted waters," said Jason Dickerson, a budget expert at the state Legislative Analyst's Office. "We've never been here before."

What got the state to this point is a combination of plunging tax receipts brought on by the recession, the state's years-long inability to balance its budget and the continuing international credit crunch.

The state needs to borrow every summer because most of its income-tax receipts flow in during the winter and spring. But this year, the need is bigger than ever: Even if lawmakers balance the budget, California will need $15 billion to $20 billion in short-term loans to make it through the year. It is unclear whether Wall Street will put up that much cash. California's credit rating is in the cellar and the state has never secured a short-term loan that large.

That is where the federal government comes in -- or so state officials hope.

Lockyer and Schwarzenegger say last fall's federal bailout legislation gave the Obama administration legal authority to back the state's loans. Now is the time to exercise that power, they say. Under their plan, the federal government would guarantee private lenders that they would be paid -- with taxpayer money from across the country -- if California defaults on its loans. The idea is to take the risk out of lending to California so the banks will put up the funds.

"The state's view is, if they can bail out the auto industry, they can do this for us," said attorney Robert Feyer of Orrick, Herrington & Sutcliffe, which is advising the state on the matter.

Whether the Obama administration has that authority or would have to get approval from Congress remains uncertain, depending on interpretations of the bailout legislation passed in the fall and modified in January. Whether officials would be willing to step in even if they could is unknown. White House officials will say only that they are mulling it over.

What is clear are the huge obstacles, both in politics and policy.

Rep. Jerry Lewis (R-Redlands) predicted little sympathy for the Golden State on Capitol Hill. "I have the feeling that it's going to be a long time before Washington decides that they're going to ask Kansas or Wisconsin to help with California's funding problem," he said.

Arturo Perez, a fiscal analyst with the National Conference of State Legislatures, said he did not expect other states to lobby Congress for similar guarantees. A number of states have already finished their legislative sessions and passed budgets for the new fiscal year, he said, and no other states have budget gaps on the scale of California's.

But if California sets the precedent, other state and local governments could make similar demands. And if the backstop were made available to other state and local borrowers besides California, the U.S. would run the risk of creating another bailout "moral hazard" -- in this case, encouraging borrowing by making it less expensive, said Matt Fabian, senior analyst at the research firm Municipal Market Advisors in Westport, Conn.

But if the administration were to balk and leave California unable to borrow what it needed, the fiscal calamity facing the largest U.S. state could unnerve foreign investors who might see it as a sign of deeper American economic woes.

"If they don't do something . . . what does it say about the dollar and the U.S.?" Fabian said.

California Sen. Barbara Boxer, who met with Schwarzenegger in the U.S. Capitol on Tuesday, said Wednesday she was working to persuade Geithner to provide the federal backstop. She said Treasury officials appeared to be split over the idea.

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