It's all in the discount rate and turnover. Volume and spread. Don't get caught with a defaulting hot potato and you're minting money [and mixing metaphors -ed].
California May Resort to IOUs
What's an IOU worth from the nation's most financially troubled state? Thousands of California businesses, nonprofits, and local governments are about to find out.
The Golden State is supposed to finalize its 2009-10 fiscal budget by June 30, but the state's Democrat-controlled legislature and Republican governor are at odds over how to plug a $23 billion funding gap. A plan passed on June 28 in the State Assembly would result in sharp hikes in taxes and fees as well as cuts in government spending. Governor Arnold Schwarzenegger has said he's in favor of more structural changes, such as reducing the pension plans of future state employees.
The State Assembly's current budget plan calls for increases in vehicle registration fees, cigarette taxes, and a 10% tax on oil production in the state. "I will veto any bill that punishes taxpayers for Sacramento's failure to live within its means," the Governor declared on June 29. "It's time for the legislature to send me a budget that solves our entire deficit without raising taxes."
Absent a last-minute resolution of the budget stalemate, State Controller John Chiang says that starting on July 2 he'll begin issuing IOUs to thousands of recipients of state funding—everyone from college students to landscapers who work at government facilities. The so-called registered warrants will be promises that the state will pay the money back as soon as it has the cash. The state projects that will happen by October, even though Chiang says California faces a $3 billion cash shortfall in July that will jump to $6.5 billion by September. "Unfortunately, the state's inability to balance its checkbook will now mean shortchanging taxpayers, local governments, and small businesses," Chiang said.......A secondary market in IOUs?
Jonathan Brown, executive director of the Association of Independent California Colleges & Universities, says his 75-member colleges will likely receive IOUs for tuition reimbursement under a state program called Cal Grants. He says the schools will keep students enrolled and hang on to the warrants until they can be redeemed. The cash crunch is likely to be severe at state universities that receive much more of their funding from Sacramento, he says. Many have already had to cut staff and eliminate programs because of the state's budget woes. "It's causing them some real heartburn," Brown says.
Merle Thompsen, a landscaping contractor in Reseda, Calif., says he now considers himself fortunate that he didn't win any bids recently to provide services at state facilities. Thompsen says he remembers the last time the state issued IOUs, contractors were given the option of continuing to work or halting projects. Stopping the work is usually more complicated, requiring contractors to stabilize the site before they leave. "That costs the state more money," he says. "It's almost easier to keep working."
Thompsen says he also remembers a secondary market developing where independent financial firms offered to cash in the IOUs for a fee of anywhere from 6% to 20% of the note's value. "It's expensive," he says....