Warning Issued Over State’s Finances

State Controller Steve Westly warned Gov.-elect Arnold Schwarzenegger on Monday that California is in danger of “losing control of its finances” if it is unable to raise $13 billion through a planned bond sale that could face trouble in court.

In a letter to Schwarzenegger, Westly said California may not have enough cash flow to pay vendors and others by late spring, when billions of dollars that the state borrowed in the spring from a consortium of banks must be repaid.

“We will run out money by June if we do not sell these bonds,” Westly said in an interview, adding that he will be raising the issue today in his first meeting with Donna Arduin, the governor-elect’s top financial advisor.

If a ready supply of cash is not available to pay off the loans in June, the banks would have the power to effectively garnish all incoming state revenues until the debts are satisfied.

Many state operations could come to a standstill, and interest on the debts would automatically jump from 1.1% to 7% -- a rate the bond rating agency Moody’s Investors Service calls “onerous.”

“I will go over this letter with [Arduin] line by line,” Westly said. “We are at risk of having to issue IOUs for the second time in a decade. The difference this time is we have had our bond ratings downgraded three times, and we have already had legal challenges to our borrowing.”

Westly, a Democrat, sends his warning to the incoming Republican governor a week after fellow Democrat and Treasurer Phil Angelides alerted Schwarzenegger to similar concerns.

“This is consistent with information the governor-elect has had for some time,” said Schwarzenegger spokesman H.D. Palmer, who said the governor-elect will announce his plan for moving forward in the coming weeks.

“He is continuing to deal with those issues through the work his transition office is doing with state finance officials and the work Donna Arduin is doing auditing state finances.”

The borrowing at issue includes $10.7 billion in “fiscal recovery bonds” approved in August in the current year’s budget to pay for the deficit accumulated through the last fiscal year. Opponents who have filed suit to block the bond sales, originally planned to begin in February, say they violate a prohibition against such borrowing in the state Constitution.

A smaller bond sale to help plug the deficit has already been blocked by a Superior Court judge in Sacramento as unconstitutional. That case is on appeal.

Schwarzenegger has hinted that he may bring the larger borrowing before voters, whose approval would shield it from constitutional problems.

But it would need to be voted on by March if the proceeds are to be available in time to pay the June debt on time and keep the state solvent. Getting it on the ballot by then requires legislative action within the next six weeks or so.

Moody’s has echoed Westly’s concerns, alerting its clients on Friday that the bond situation combined with the loans coming due has created “a very significant risk factor for the state” and investors.

The only specific plan for the budget Schwarzenegger has announced is one that threatens to increase the state’s deficit by $4 billion: rescinding the car tax hike that took effect this month.

Advisors to Schwarzenegger have suggested that an unanticipated increase in tax revenue now flowing into state coffers thanks to an improving economy -- revenues were $500 million above projections for the last quarter -- could pay for the lowering of the car tax.

Westly warned that would be an overly optimistic assumption.

“We may wind up $1 billion ahead of what was forecasted this year,” he said. “It’s terrific we found it, but it’s like finding cash in the pocket of your winter coat. It’s great to find it, but there is not enough there to pay the rent.”

Moody’s expressed a similar sentiment, warning that cutting the tax “without credible offsetting budget adjustments” would likely put the state on the agency’s “watch list” for another downgrade. California already has the lowest bond rating of any state.