California's IOU Fever Is Likely To Spread To Other States

California has begun to issue IOUs to many state vendors as it grows low on cash. The largest state in America as measured by GDP is up against a $24 billion deficit.

According to the FT, “Once the US’s richest state, California now has the dubious distinction of having the worst credit rating in the country.” The state could be joined by Michigan, Florida, and New York as those states face similar problems balancing state budgets.

The IOU issue has far-reaching consequences. The first of these is that many critical vendors may refuse to take IOUs. Companies that work for states that are in financial trouble may simply refuse service, if they can afford to forgo the business. There is no guarantee that the IOUs will be paid, particularly if any of the struggling states are forced into some form of receivership. California could lose access to critical suppliers that help maintain its infrastructure and programs that are critical to compensating state employees.

The other side of the IOU coin is just as troubling. Some of the firms being asked to take IOUs cannot continue to operate without cash flow. They cannot pay their employees or their operational expenses with promises from the state. Some of these firms may be forced to close. That will deprive California of their services and it will add to the rolls of the state’s unemployed which will pile another burden onto the heap of unemployment benefits and social services. The IOU program becomes a vicious circle.

There is a very reasonable chance that some of America’s largest states will begin to default on critical obligations including essential services and bond payments. These states will no longer be able to raise money in the capital markets. They will have no where to go other than the lender of last resort.

And, that would be the US Treasury which is already straining under the obligations of the US budget deficit.

Douglas A. McIntyre