This article was last updated on June 21
I remember as a kid, my brother and I used to exchange IOUs (I owe you) for favors owed. In most cases this was for some form of candy or an exchange to do assigned chores around the home. Because we had no money, the IOU’s provided the exchange platform for barter. Of course after we got older and had real money this concept became outdated, with this “kids” exchange system left behind.
Well, looks like the once mighty state of California has now adopted this kid’s play concept as the state faces huge budget deficits, forcing it to issue IOUs – which are officially called individual registered warrants – to many state vendors as it grows low on cash. The largest (and once richest) state in America as measured by GDP is up against a $24 billion deficit, after state leaders failed to agree on budget solutions. State Controller John Chiang said that without IOUs, California would be unable to pay its vendors and employees, since there is no cash left in the state coffers.
While California may be first state to start issuing IOUs instead of paying in cash, it will not be the last as many states combat looming budget deficits and tightening cash flows.
Can my state start issuing IOU’s?
Yes. There is a very reasonable chance that some of America’s largest states will begin to default on critical obligations including essential services and bond payments, as they run out of cash. California could be joined by Michigan, Florida, and New York as those states face similar problems balancing state budgets. However if the economy and unemployment get’s worse and state tax revenues continue to fall, then a majority of states could join the list of IOU issuers. There’s already an active market for the Californian IOU’s (thanks to their 3.75% return) which can easily become a national market. We all know the bailed out, once again mega profitable investment banks will be on hand to facilitate this new market – for a nice fat cash fee off course.
The IOU issue has far-reaching consequences. The first of these is that many critical vendors may refuse to take IOUs, if they can afford to forgo the business. This will mean the state will have to pay an IOU premium to get vendor services, or end up with the worst and most desperate vendors for state services. There is also no guarantee that the IOUs will be paid, particularly if any of the struggling states are forced into some form of receivership.
The story for recipients of IOU’s is just as troubling. Some of the firms being asked to take IOUs cannot continue to operate without cash flow. They cannot pay their employees or their operational expenses with promises from the state. Some of these firms may be forced to close. That will deprive states of their services and it will add to the rolls of the state’s unemployed which will pile another burden onto the growing heap of unemployment and social services. The IOU program becomes a vicious circle.
The federal government (via the US treasury) is already helping some states, but the government is already straining under the obligations of the US budget deficit and any help will only be temporary and not enough if the economy continues to deteriorate.
Can I start getting paid in IOUs!
Yes, but only if you are in some way performing vendor or non-employee services for the state government. In most states, laws bar paying state workers and retirees with anything other than real money. Public or Private companies still need to pay in cash. Retirees and those on disability benefits are also covered.
The federal Social Security Administration has notified California that it will continue to pay in full both the federal Supplemental Security Income (SSI) and the State Supplementary Payment (SSP). State officials will continue to work with the Social Security Administration to ensure California’s 1.2 million SSI/SSP recipients are not affected by IOUs.
Even if you do get paid in IOUs, many financial institutions will immediately exchange if for cash – for a fee and the interest payment due at maturity. This was the case when IOUs were required in 1992, and despite a worse financial situation, the short term return may make it a tempting option for those with lots of cash. At the end of the day, IOU’s should only be a short term fix and will force a state government to act to resolve the surrounding crisis. Unfortunately this will mean cutting a number of public services.
In the current economy, if you rely on the government for any form of payout, be wary of potentially gettin
g IOU’s and the best way to prepare for the potential receipt of IOU’ is to start building your cash reserves now. If you are a business owner, then try and diversify your client base to avoid relying on state or federal government work as your main source of revenue.
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