What Happens When a State Runs Out of Cash?

State eNews Issue #38 | January 20, 2010

In the midst of California’s budget troubles, its only remaining A-level credit rating from a major firm was just downgraded to an A-minus, according to The Los Angeles Times.

Standard & Poor’s cut that rating on the state’s $64 billion in general-obligation debt and warned the state’s outlook wasn’t good, meaning future downgrades could occur, the newspaper reports.

California isn’t the only state facing consequences that come from budget shortfalls. Other states are in bad budget shape, too. 

“The fiscal black hole that we’re in has not improved,” said Justice Richard Huffman of the California Court of Appeals in the Fourth Appellate District in San Diego.

Most have heard about the state’s budget woes, which are affecting nearly every state agency and function. The judicial branch isn’t immune from the fallout of the state’s $6.3 billion mid-year budget gap for the 2010 fiscal year or its anticipated $14.4 billion budget gap for the 2011 fiscal year, according to figures from the Center on Budget and Policy Priorities in Washington, D.C. In fact, little known budget-cutting measures have forced the state’s courts to shut down for one day a month, according to Huffman.

An estimated 80 to 90 percent of the state’s judges are even giving up part of their pay, either by voluntary salary waivers that fund trial court operations or through direct contributions that go to funding their own courts, according to Lynn Holton, spokeswoman for California state courts. Huffman is one of the judges voluntarily giving up part of his pay to help his own court.

But some are wondering about other legal ramifications of state budget troubles. Standard & Poor’s cited concerns over California’s finances in its downgraded rating, including a possible shortage of cash, according to The Los Angeles Times. But just what would happen if a state ran out of cash?

Arizona State Treasurer Dean Martin is no stranger to handling cash shortages and other budget issues. His state has been in recession since January 2007—that’s when the state first ran out of cash.

In fact, a few days before Christmas 2009, Arizona’s credit rating was downgraded by Moody’s because of failure to pass a balanced budget, Martin said.

“The state’s broke, basically. The state is literally out of money,” Martin said. Based on the treasurer’s office budget early warning system, the state ran out of cash for the first time since the dot-com bubble in January 2007, Martin said. That meant the state’s checkbook was negative and it was burning through its reserves, he said.

That said, a state can’t actually file for bankruptcy, Martin said.

“The state cannot go into bankruptcy—bankruptcy laws do not apply to states,” he said. “Basically you slip into defaults, which is kind of the same thing. You bounce a check effectively and when you bounce a check you send the person an IOU.”

California has been sending out IOUs since last year; Arizona is also sending them, although not to the general public.

Between Thanksgiving and Christmas last year, Arizona was at the point where it could no longer guarantee the state was in a position to always pay its bills, a situation much like California’s, Martin said. At that point, the state needed to come up with a procedure for issuing and handling IOUs, he said, because the last time IOUs were used was during the Great Depression and the state had no surviving records of that.

Martin said Arizona is actually worse off than California. Percentage-wise, its shortfall is a higher percentage of its general revenue fund than California’s, he said.

California is just so big that its budget problems are larger due to the sheer shortfall amount, which is in the tens of billions of dollars, while Arizona’s budget shortfall is a few billion dollars, according to the Center on Budget and Policy Priorities.

“Although our problem is worse than California’s, we have not had to resort to sending IOUs to (the) general public,” Martin said. But at the same time, “it’s allowed the legislature and the governor to ignore the problem longer.”

And that’s what happens when a state runs out of cash—the IOUs keep coming. The problem may continue as long as states don’t address structural problems within the budgets, Martin said. As long as states spend more than the revenues that come in, it spells trouble, he said.

“What happens from a state perspective, as long as the state doesn’t have a permanent structural solution, they continue to erode their cash base,” Martin said. And when that happens, states will have to resort to drastic measures to bring in more cash.

Arizona just sold a variety of state buildings, including the archives building, the tower at the capitol that houses the governor’s office and six prison buildings in Florence, according to the Arizona Republic. The proceeds from the sale generated enough cash to pay the state’s bills for about a month, Martin said.

The state will lease the buildings and hopes to buy them back in the future.

Drastic measures to raise cash may become more frequent as states continue to run out of money, experts say. Nearly every state faces a budget shortfall, according to the Center on Budget and Policy Priorities, and although most states have closed budget gaps for the 2010 fiscal year, all but 10 states and Washington, D.C., face an anticipated budget shortfall for the 2011 fiscal year budget.

Other Resources

  1. Center on Budget and Policy Priorities

  2. “California’s debt rating cut again on budget woes,” Los Angeles Times

  3. Arizona Treasurer’s Office