California's IOU Policy Puts Solution Providers At Risk

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Solution providers and other businesses in California could quickly suffer from credit and cash flow crunches in the wake of the state government's budget crisis and subsequent decision to pay its contractors and citizens with IOUs in lieu of cash.

Lending policies, already tight in the wake of the nation's economic downturn, are getting tougher for solution providers who are starting to get paid with California's registered warrants, also known as IOUs. And because many banks are refusing to accept IOUs as deposits, cash flow management could become a problem as well, solution providers said.

The ability to extend credit to state agencies and get credit from financial institutions become issues when the state starts issuing IOUs, said John Riley, co-owner of Sacramento Technology Group, a Folsom, Calif.-based solution provider that does a significant amount of business with the state.

Sacramento Technology Group, which does half of its business with the state of California, took a few orders from the government on June 30, but none since, Riley said.

"It's difficult to extend credit to the state," he said. "We need to decide if we can do more reseller business with the state. It's up to the bank or our flooring company."

California's budget crisis is coming to a head this summer as state tax revenues plummeted with the U.S. economic downturn and the state legislature's inability to adopt a budget for the current fiscal year.

As a result, the California state controller on July 2 started issuing the IOUs instead of paying cash to many of its contractors, as well as to individual citizens, including welfare recipients and students receiving financial aid.

The state controller's office estimates that it will issue $2.8 billion in IOUs for the month of July, including $424 million in vendor payments, $141 million in small business payments and $364 million in capital outlays.

The IOUs come with an interest rate of 3.75 percent and a promise to redeem them in cash on October 2.

At this point, there is no guarantee the state can even pay back the IOUs on October 2, as it depends on the state legislature agreeing on a budget, according to Jacob Roper, a spokesman for the state controller's office.

"If a budget is not adopted by October 2, we are in a world of hurt far worse than ever before," Roper said.

While many smaller banks and credit unions are accepting deposits made with the IOUs, a group of larger banks including Bank of America, Citigroup, Wells Fargo and J.P. Morgan Chase said last week that they stopped accepting the IOUs on Friday.

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