By John W. Schoen Senior producer
msnbc.com
updated 7/6/2009 11:08:42 AM ET 2009-07-06T15:08:42

If California is going to issue IOUs instead of paychecks for employees, can the employees use the IOUs to offset their tax liabilities?
— Ruth D., Ohio

It would be a fitting use for this quasi-cash to send it right back to the government. But for most state workers, it likely won’t get that far.

For starters, the law bars paying state workers with anything other than real money. But plenty of other people owed money will have to figure out how to get by for a bit without it.

To save cash, California will print up $3.6 billion in funny money this month to pay some of its other bills — mostly to vendors who sell goods and services to the state. These include both major corporations and mom-and-pop operations that can ill-afford the disruption in their cash flow. Some of these businesses may have to fold, generating more layoffs in a state where the official unemployment rate already stood at 11.5 percent in May.

In the short run, businesses or individuals could send the bogus bucks right back to Sacramento to pay taxes. But these IOUs will likely mature in 90 days, which means the state will convert them back into cash — with interest — before most people have to pay their taxes in April. In the meantime, the IRS will continue to require that employers withhold taxes from most workers’ paychecks. So the IOUs can’t be used to offset that federal tax liability.

It’s also not clear whether banks will accept this funny money once it’s issued. Most did so the last time this happened in 1992, but the financial problems of both the state and the banks are much worse than they were 17 years ago. If banks do accept IOUs, they’ll probably pocket the interest paid when the IOUs convert back to cash. Or they may charge a fee to cover the risk that these faux dollars turn out to be worthless.

Given the sorry state of the state’s financial and political affairs, that’s not an unreasonable fear. State officials in Sacramento have been flailing for years as this budget nightmare has escalated. But they didn’t create this mess by themselves. The people of California, having led the nation in a “property tax revolt,” have now shot themselves in the foot with a government that spends $26.3 billion more on services than it takes in on taxes.

This is roughly equivalent to cash-strapped family members who can’t agree on where to stop spending — so they just keep running up their credit cards and then ignore the bill. It worked for a few years. Now, after raiding the piggy bank and selling everything they can think of on eBay, there’s no more cash. Friends and family have cut them off. But instead of cutting spending or looking for a second job, these folks go right on spending.

State officials insist they won’t default on their bonds, a prospect that could have a catastrophic impact on the financial markets. Issuing IOUs may yet bring a round of defaults by local governments and state agencies that rely on the Sacramento to honor its financial commitments with real cash. By using IOUs, state officials are passing along the financial mess they created to local officials. If those local governments run out of cash, they may have to default payments to investors who bought their municipal bonds.

California may have started this trend of living beyond its means, but other states have picked up the same bad habit of winning favor with voters by offering popular services — without having the courage to explain to those voters how much it all costs. Now, with the collapse in property values and the slowdown in retail sales, tax revenues have plunged and budget gaps have widened. But in most statehouses, elected officials are still stuck at the finger-pointing stage.

Despite all the political theatrics, the solution is pretty simple. Taxpayers have to pay more to cover the cost of the services they don’t want to give up. Or they have to expect a lot less from state government — including big cuts in basic services like education and road repair.

Just like the family that spent more than it could afford during the bubble, the party is over for state governments. We may be only beginning to feel the hangover.

You are a financial writer for MSNBC. The editorial staff appears to be in the hip pocket of President Obama. He can do no wrong. However, when I read the financial writers, like you, they are much more conservative and skeptical of the present economy and the present Congress and administration. Is my perception correct? Why?
— Harold N., Dayton, Ohio

I disagree with your perception that my colleagues at MSNBC are broadly uncritical of the Obama administration. In general, I think some readers are quick to see bias where none exists. (I will say that I think all cable television news channels have strayed too far in offering up political opinion as “news.”)

To your broader question, I tend to agree that many financial writers are more skeptical about the economic outlook and forecasts offered up by Congress and the White House. This is not a partisan issue; politicians of all stripes are notorious for glossing over economic problems. (See: State budgets, California). Politicians can generally say whatever they want — as long as they can keep a straight face.

The financial markets, however, are a lot less forgiving. It’s been my experience that people tend to stick closer to the facts when they decide where to save or invest than they do when formulating a political opinion. So the economy and financial markets represent a kind of popular referendum on government policies, one that’s often a lot easier to read than opinion polls and usually much more reliable.

The markets also provide an important reality check. There’s nothing particularly wrong with Obama’s ambitious agenda: save the world from global economic collapse, defuse the ticking bomb of runaway medical spending, salvage what’s left of the U.S. auto industry, etc. Other than a few misguided, hyperpartisan malcontents, I don’t know why anyone would want to see any president fail.

But if, for example, Congress and the White House can’t control federal spending and shrink the deficit, anxious Treasury bond buyers will demand a higher return, and interest rates will go up. You could argue that the market is wrong to demand those higher rates. Or you could disagree over which policy, exactly, was responsible for those deficits. But you can’t argue about whether rates have gone up or down — or what the impact will be.

Lastly, we get a lot of mail from readers asking why we’re so gloomy all the time. These readers seem to think that a frank discussion of economic risks and underlying problems hurts consumer confidence and, in turn, does further damage to the economy. We think they’re wrong on several counts.

First, it’s not our job to cheerlead the economy: There are more than enough politicians already doing so. Second, it serves no purpose to report only “good” economic news and ignore the warning signs. But most importantly, people are smart enough to make their own minds about how well or poorly the economy is doing. There’s little we could write that would change that.

Not too long ago the big banks were begging for help and painting the doomsday scenario. Suddenly, when the executives found out that they will no longer be able to stuff their pockets with obscene salaries, the banks no longer needed the bailout money. Have I missed something?
— P.H.Tampa, Fla.

No. I think you’ve pretty much got it covered.

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