California seeking $7 billion emergency loan from Federal Government

California may be the next domino to fall in the global financial meltdown, and it has gotten surprisingly little attention. Because of the credit crises, the State my had difficulty arranging financing for the bond sales it uses to generate cash flow to run the government. Governor Schwarzenegger has written a letter to the Secretary of the Treasury, Henry Paulson, advising him that California may need a $7 billion emergency rescue loan from the Federal Government. State Treasurer Bill Lockyer warned that the State’s cash revenues will dissipate completely by the end of the month, and the state’s 5,000 cities, counties, and school districts will face job layoffs and payments for law enforcement agencies, teachers, nursing homes and an array of other services and government entities could soon be suspended.  As reported in Financial Times:

California’s economy, which would be the eighth biggest in the world if the state was a separate country, is teetering on the brink of a financial crisis intensified by the credit crunch. California is weeks away from running out of money. In a letter to Hank Paulson, the US Treasury secretary, Arnold Schwarzenegger, California’s governor, last week admitted an immediate $7bn was needed to pay for essential public services, such as police and fire-fighters.

California would normally generate interim funding by issuing “revenue anticipation notes” in the short term credit markets to tide it over until tax revenues arrive later in its financial year. But the door to the credit markets is firmly closed.   Other states are also suffering from poor economic conditions and declining tax revenues.

Florida, Nevada, Massachusetts and Ohio have dipped into their reserves  to maintain spending, according to Robert Kurtter, managing director of Moody’s US public finance group. But he said California’s situation was unique as it often relied on the capital markets to maintain spending commitments.  “When you have that dependency year-in-year-out you are going to get caught out when the markets are disrupted,” he said. “And that’s exactly what happened.”

Unlike most other states, California does not have a reserve fund and because it depends heavily on capital gains tax and stock option realisations, its revenues can be volatile. The looming cash flow crunch has caused considerable alarm.  “We are two weeks or so away from not being able to pay teachers and fire-fighters,” said Ross DeVol, director of regional economics at the Milken Institute, a Los Angeles-based think-tank.

Passage of the $700bn bail-out bill last week may not have solved the state’s immediate problems. “If we could get through the next two or three weeks without another financial institution being taken over that might restore confidence in counter-parties. But I don’t think the bill will free up the credit markets in the near term.”

Bill Lockyer, California’s treasurer, said immediate cash needs could be met with as little as $3bn.  But to end its reliance on the markets, California must first become better at balancing its budget, said Mr Kurtter. “Typically, when entities get into trouble it begins with cash flow. And when you are chronically running budget deficits, your cash is going to dry up.”