Today is the first day that most large banks stop taking IOUs from individuals and small businesses.  For those left holding them, the options are limited.  Citibank agreed to a one-week extension, and Bank of the West will accept them – but only for existing customers.  Other big banks may offer lines of credit or other short-term bridges for customers, but on a case-by-case basis.  IOU holders needing cash might be able to try credit unions, or inevitably, check-cashing stores.  And this all appears to suit Arnold Antionette just fine:

State Treasurer Bill Lockyer tried to persuade the big banks to change their minds about the IOUs. “We’re just trying to convince them that it would be in the best interest of their customers and the best interest of taxpayers to give it more time,” said his spokesman Tom Dresslar.

Gov. Arnold Schwarzenegger made no such attempt at persuasion. “His focus is to get a solution to our budget so we don’t have to deal with IOUs,” said his spokesman Aaron McLear. “I don’t think it was anyone’s expectation that they would honor them forever.”

Emerging from a meeting with legislative leaders Friday, the governor would say only that “IOUs are one more reason to get the budget done as quickly as possible.”

In 1992, the last time the state issued IOUs, the major banks accepted them for about a month. Their refusal to go any further was widely seen as a move to pressure officials to pass a budget.

Yes, of course, this is why he vetoed solutions that would have stopped the issuance of IOUs in the first place.

Meanwhile, John Chiang’s latest release of the state economic picture shows a $10 billion dollar shortfall in Fiscal Year 2009, and a still-contracting revenue picture that has led to a $4 billion dollar delay in payments to local school districts.  They has planned on sending out the money Friday; now they will hold off until July 30.

And the Big Five have returned to the negotiating table today, where they claim “constructive” negotiations, which we’ve heard plenty of times before.  No word on whether the Governor continues to hinge a budget deal on uncorroborated fictions about fraud in social services or fiscally unwise cuts to programs like welfare.

Bloomberg reports that people are lining up for those souvenir Arnoldbucks.

Controller Chiang said the warrants can be transferred between individuals, setting up the possibility that a secondary market for the IOUs may develop. Already ads are appearing on Web sites such as Craigslist offering cash for the IOUs at below face value.

In such a transaction, the person who gets the IOU would get most of the cash they were due the state, while the person buying the IOU might then hold onto it until maturity and earn the face value plus the 3.75 percent interest.

At least one person offered to buy an IOU at more than face value as a keepsake.

“I am interested in purchasing a ‘State of California IOU’ as a souvenir,” the ad reads. “I figure it would be an interesting thing to have around when my grandchildren are fighting over my stuff after I’m dead and gone. I will pay two times face value (up to $100, or $50 face value) for a warrant/IOU.”

Of course, after July 10, the deadline that banks like BofA and Wells have given for exchanging these IOUs for cash, souvenirs may be the only value for these IOUs for a few months.  Maybe Arnold will go to a baseball card convention and sign them himself!

Here’s another FAQ about who receives IOUs and who does not.  The unemployed, SSI/SSP recipients, state employees and retirees, IHSS and Medi-Cal providers will NOT receive IOUs.  Welfare recipients, contractors with the state, local governments, and income tax refund recipients WILL get them.  Felix Salmon made a handy chart that suggest the haves will keep getting paid and the have-nots won’t, and that’s somewhat true, but some have-nots who have the benefit of their services being partially provided by the Feds will get paid as well.  In general, where you stand does depend on where you sit, in this crisis.  This again makes clear that the idea of California debtholders, who get priority of payment in the state constitution over everything but education, getting stiffed by the state is a ridiculous one that pretty much cannot happen, and lowering bond ratings should be rightly seen as Wall Street gouging.

And I’ll allow Karen Bass to explain exactly who’s responsible for this particular outcome of IOUs and lowered bond ratings.

Small businesses, students, seniors, and taxpayers will all start receiving IOUS. This shameful day didn’t have to arrive. In fact, Governor Schwarzenegger had several opportunities to prevent it.

On June 12 Governor Schwarzenegger unilaterally blocked the Controller’s authority to secure short-term loans to avoid the cash crisis. He said, “let them have a taste of what it is like when the state comes to a shutdown — grinding halt.”

On June 25 after the governor called Senate Republicans to his office for private meetings, $4 billion in immediate cash solutions that had been passed on an overwhelming bipartisan majority in the Assembly were killed in the Senate.

Most recently, the governor vetoed a comprehensive package of budget solutions supported by majorities in both houses of the legislature that would have resolved the $19.5 billion deficit, left a $4.0 billion reserve, avoided the cash crisis and prevented IOUs […]

We did offer, as a sign of good faith, to begin work immediately on reforms regarding restructuring Medi-Cal and eliminating fraud in the IHSS program. We also committed to working with the governor on other reform legislation for him to sign. But the governor wouldn’t take “yes” for an answer. So California businesses, taxpayers and students will be receiving IOUs simply because Governor Schwarzenegger thought it was more important to immediately force last minute changes such as reducing future employee pensions, fingerprinting elderly and disabled Californians who receive services, and denying kids food stamps if their families can’t access a computer to sign them up for the program.

See Noreen Evans for more.

The budget gap grows by $25 million a day and we have wasted billions of taxpayer dollars because the Governor wants to teach everyone a lesson.  I hope that IOU secondary market is bigger than eBay, because those suffering with the consequences of dysfunction are going to need the help.

The IOUs are on the verge of being distributed.  The Pooled Money Investment Board met today to hash out the terms for the IOUs, and surprise, there were some differences.  The Governor wants a paltry 1.5% interest rate for the IOUs, and flexibility on repayment until as late as June 2010.  That would be worse than a 1-year CD.  Controller Chiang supports the staff recommendation of 3.75% interest rates and repayment in October.  Chiang won.  The board approved his terms.

The reason to offer a more attractive interest rate is to ensure that banks will actually cash them.  Wells Fargo and Bank of America announced they will accept them, but only until July 10; after that, it’s anybody’s guess.  Golden 1 Credit Union and Tri Counties bank of Chico also agreed to accept the warrants.  This article gives a good rundown of how the IOUs will work.  If your bank won’t cash them, you’re basically stuck with a piece of paper until October.

The most important question, of course, is why we’re going down this costly route at all, when the Assembly and Senate Democrats fashioned a solution to avoid this.  The answer is that the Governor wanted some leverage, the people be damned.

If the stigma of issuing IOUs triggers a budget deal in the coming days, Gov. Arnold Schwarzenegger might find redemption in his strategy of quashing a stopgap solution that would have avoided those non-cash payments.

But if no budget deal emerges soon, Schwarzenegger will have helped saddle the state with a lower credit rating and have nothing to show for it.

As a negotiating strategy, Schwarzenegger is counting on public pressure to mount against the Legislature as California issues IOUs today for only the second time since the Great Depression. The Republican governor could have backed legislation to avert IOUs this week, but he demanded that lawmakers solve the entire budget problem, which grew Wednesday to $26.3 billion […]

Schwarzenegger wanted a full budget deal, and part of his calculation was likely that IOUs ramp up the stakes and force lawmakers to reach that goal sooner. Without IOUs, he figured lawmakers might have delayed compromise on the rest of the package, costing the state in a different way.

“If he had signed the stopgap measures, the Legislature would have gone home for Fourth of July weekend and come back when the threat of IOUs came up again,” said Tim Hodson, executive director of the Center for California Studies at California State University, Sacramento. “I’m sure the governor went over this and thought: Are the consequences of the delay worse, and would he have lost the leverage that he has now?”

Well, this is a game played with people’s lives.  If banks won’t cash IOUs, you can be sure Rite-Aid won’t accept them.  Or landlords.  Or health care providers.  In addition, this little power play cost taxpayers between $2 and $7 billion dollars, which I don’t see Schwarzenegger going into his wallet to cover.

Rather than shock doctrine the legislature into making major policy changes as a condition of passing a budget, a more likely scenario is that this train wreck will spark reform efforts to finally get off this perpetual track of hijacking and stubbornness.

If California has become ungovernable, and teeters now on the brink of bankruptcy, it is due less to excessive spending than a deficit in democracy – the very essence of which is majority rule. A simply worded, one-paragraph initiative to restore majority rule in the Legislature might well prove resoundingly successful with a crisis-weary electorate. And while it may not be sufficient in itself to repair the state’s balance sheet and fix its broken governance, restoring majority rule is the necessary first step toward ending gridlock, renewing public confidence, and preventing extremists of whatever stripe from holding future legislatures hostage to their own narrow agendas.

If no deal is reached between the Governor and the Legislature in the next 14 hours, California will start to issue IOUs to companies that do business with the state (mostly small businesses), taxpayers expecting refunds, and agencies delivering assistance to the most vulnerable members of society – welfare recipients, the elderly, disabled and blind, and college students expecting aid grants.

The biggest variable with these IOUs is whether or not banks will honor them, a decision that they have yet to reach.

The deciding factor could be California’s banks. If they’re willing to honor the registered warrants, or IOUs, then the problem becomes manageable for the scores of small businesses and local governments that rely on dollars flowing from Sacramento. They’ll be able to cash the IOUs.

But if the banks resist, billions in state payments will be effectively delayed – putting renewed stress on a state and region already suffering from a deep recession. One Rocklin company, a temp firm that relies heavily on state business, has already laid off five workers in anticipation of a cash squeeze.

So far, no banks have committed to honoring the IOUs, said Hallye Jordan, spokeswoman for state Controller John Chiang.

She said banks are probably waiting to see how much interest the state will pay on the IOUs – a figure that won’t be decided until Thursday, the same day Chiang is scheduled to issue IOUs. The notes will total $3.36 billion, with about $500 million targeted for the private sector.

In 1992, banks generally honored the IOUs by cashing them on demand.  If you haven’t heard, banks are in a slightly worse financial picture now than then, and might not be willing to float bridge loans for the state, even with generous interest, this time.  And of course, if the banks agree to honor the IOUs, the state will be paying out hundreds of millions of dollars to them in short-term interest.

If the banks fail to honor the IOUs, you can just add that to the severe pain being felt by California residents at this time.  The personal bankruptcy filings which soared in Southern California in the first quarter will only increase.  The foreclosures, which have not only continued for residences but commercial property like hotels, will expand.  With small businesses forced to cut back due to cash flow cutoffs from the state, expect more unemployment and a continued erosion of the tax base, leading to even larger budget shortfalls.  This is a death spiral from which we will find it hard to extricate ourselves.  California’s role as the biggest of the “50 Herbert Hoovers” truly can threaten national economic recovery.

The CA-32 race to replace Labor Secretary has less than six weeks to go until the primary.  We know about the two major candidates; Board of Equalization member Judy Chu (not to be confused with Betty Chu, who will appear directly above her on the ballot and surely cause some errors among voters) and State Senator Gil Cedillo, whose extreme spending of campaign contributions on shopping, meals and lavish hotels made the LA Times this weekend and caused a stir.

Somewhat less remarked-upon has been the candidacy of Emanuel Pleitez, a product of East Los Angeles and Woodrow Wilson High School, who matriculated at Stanford, joined the advisory board of Voto Latino (a group that encourages voter registration and engagement for the Latino community), worked for Democratic lawmakers like Antonio Villaraigosa, Tom Daschle and Hillary Clinton, and worked on the Obama transition team at the Treasury Department.  On Friday I had the opportunity to chat with Pleitez about his life experiences, the financial crisis, housing policy and a host of other issues.  A paraphrase of that conversation follows.

(As a side note, this story about one of the volunteers on the campaign, who traveled all the way from Santiago, Chile to work on it, is pretty amazing.)

Calitics: Tell me about your experiences that have brought you to this run for Congress.

Emanuel Pleitez: You know, after college and working in the private sector at Goldman Sachs, I was able to travel a lot.  And I think visiting 27 countries gave me a new perspective on what the challenges are out there in the world.  When I would go to South Africa or India, China, Brazil, I would visit the universities, and the slums, and see their struggles, and it really made me think about the issues of global poverty.  I even drove a taxicab in Myanmar!  And what I took away from all that is that the best way to create change is to start in your own backyard.  And that’s what we’re doing in this campaign.

Calitics: So how are things going?

EP: Well, we have 25 full-time staff working every day.  And our main focus is door-to-door, face-to-face contact.  We’re out canvassing every day.  A lot of people tell me that they think we’re the only candidate in the race, because we’re the only one they see.  So we feel pretty good about our position.

Calitics: Now, you worked on the transition in the Treasury Department, and one central concern that a lot of people have had with Treasury is the lack of staffed positions at the undersecretary level, and the belief that Tim Geithner has basically had to go it alone over there.  How should people look at the transition’s performance in that respect?

EP: I agree with that criticism of Treasury.  I had nothing to do with personnel, I worked in other departments.  But there are many reasons for the lack of senior staff, and I wouldn’t discount the ability and importance of the career civil servants working in the Department, who are doing a fantastic job.

Calitics: This week, the Congressional Oversight Panel released a preliminary report on the TARP program and Treasury’s performance, and they were highly critical of the lack of transparency and clarity over some of these programs, as well as a lack of accountability for the big banks.  How would you assess the various programs offered to this point?

EP: I don’t have all the details of the COP report.  My inclination is to defend Secretary Geithner, but I want people to be critical.  I think what he’s trying to do is return confidence to the markets and get credit flowing again, and we’re seeing signs that the plans are starting to work.

Calitics: How would you approach the situation with the banks.  Would you just recapitalize them forever, or seek a Swedish-style receivership or a liquidation of the insolvent firms?

EP: I would consider a receivership, but I wouldn’t make that the first thing on the table because of the expense involved and the danger to the markets.  But clearly, recapitalization alone won’t work, that’s just making capital disappear.

Calitics: What’s the biggest problem in the economy that we’re facing at this point?

EP: The biggest problem is the foreclosures right now.  Some of them are in rural districts are suburbs and they’re second, third and fourth homes, but for families in urban districts like mine, a foreclosure means the loss of everything you’ve got.

Calitics: Would you support bankruptcy judges being able to modify the terms of a primary loan for borrowers?  Isn’t there a problem with modifying securitized loans, in that the people holding the securities that have been modified can sue the loan servicers for illegally changing the terms of the security?

EP: That is a problem.  But as I understand it, cram-down is more of a threat to incentivize loan modifications and keep people in their homes.  Which is what we have to do.  Investors will get hurt anyway if the loan forecloses.  Somehow, the lenders and the investors and the home-owners have to come to an accommodation, and in that process the primary goal should be keeping people in their homes.  I wasn’t initially open to principal write-downs, but I am more so now, because we’re seeing that the interest-only modifications are not working, and people are being forced into foreclosure just a few months later.

Calitics: What are some of the other challenges facing the economy that you want to deal with in Congress.

EP: Obviously, we still need major stimulus to save jobs and transition into a new economic future.  A large part of my district is at or near the poverty rate, and we need help in these tough economic times.  I expect another trillion dollars to be spent by the government.  In my district, we need investments in public transportation and clean energy programs to reduce emissions and create manufacturing jobs.  There’s a program here called “La Causa,” which targets the high school dropout rate, and gets those kids into vocational programs for green jobs, whether it’s solar panel installation or something like that, so that they can be prepared for the 21st century economy.  We need more of that.  And we need investment in education, because any dollars spent get the greatest return in education.

Calitics: Do you plan on joining any ideological caucus in Congress?

EP: I haven’t really given it much thought, but I don’t think so.  I think all political is local, and I’d rather focus on helping my local community and responding to the concerns of my district.  Maybe I’ll join the Congressional Hispanic Caucus, that should be safe for me.  (Laughs.)

Calitics: Well, thank you for talking to us today.

EP: Thank you.

I just heard Will.I.Am on NPR talking about education cuts in California.  The budget crisis has gone mainstream.  And once everyone gets the news that tax refunds, welfare checks and student grants will be suspended because the state is out of cash, a whole lot of other people might get some awareness as well.  The dirty little secret about “liberal bastion” California is that we are not a civically engaged people, generally speaking.  The budget has been in “crisis” for decades but not enough Californians have mustered up the interest in it.  We have right-wing astroturf movements that play to base emotion, but not really citizen’s movements that ask for basic fairness.  Californians are 45th in the country in volunteering, 44th in attending community meetings and 45th in working on community problems.  Chalk it up to traffic or self-absorption or what have you, but the general take is that Californians don’t see much beyond what is in front of them.  IOUs would change that.  Well, maybe.  It depends on if the banks will accept them, which is still being negotiated.

The payments to be frozen include nearly $2 billion in tax refunds; $300 million in cash grants for needy families and the elderly, blind and disabled; and $13 million in grants for college students.

Even if a budget agreement is reached by the end of this month, tax refunds and other payments could remain temporarily frozen. Chiang said a budget deal may not generate cash quickly enough to resume them immediately […]

State officials have already designed an IOU template, Chiang said, and have been negotiating with banks over whether taxpayers could cash or deposit them if they are issued. The state could be forced to pay as much as 5% interest on delayed tax refunds if they are not paid by the end of May, Chiang said.

The last time the state issued such IOUs — the only time since the Great Depression — was in 1992.

In other words, the only way this delayed tax refund is going to work is if it causes MORE debt for the state.  But let’s go back to 1992.  This was the last big recession in the country, and California again found itself unable to pay its bills.  Tell me again how the budget problems aren’t structural.  Anyway, the state issued about $350 million in IOUs that year, about 15% of what is being prepared today.  The process was not smooth:

IOUs have caused headaches for the state in the past. California issued $350 million worth of IOUs to 100,000 recipients in 1992 during a budget impasse between then Gov. Pete Wilson and the Legislature.

A four-year legal battle ensued after some workers had trouble cashing them. The dispute was settled in 1996 with some state workers getting paid time off for the inconvenience they experienced.

Beth Mills, a spokeswoman for the California Bankers Association, said individual banks statewide haven’t decided yet whether they will accept the state IOUs this time.

Banks are barely willing to lend money, I just don’t think they’re going to be interested in accepting $2.3 billion in IOUs when the process was so difficult last time, and there is more uncertainty in the financial markets now.  And even if they do, it will not be uniform across all banks, and customers are going to have varying experiences.  

The State of the State speech that nobody watched proved the need for fundamental reform, but it generated barely a blip among non-elites.  Having trouble cashing your disabled mom’s assistance payment, that’s a whole different story.  Not to mention the fact that the continued erosion of jobs and the 5,300 public works projects that have been delayed by the state will create a lot of angry and idle minds.  Of course, the cautionary part of this is that the 1992 IOUs did not lead to structural reform.  However, we all can agree that this is a much bigger problem.

Pitchforks and torches may be at a premium.  And while it’s hard to write a new Constitution in a riot, something needs to shake up this decayed and dysfunctional system.