SAN FRANCISCO (Reuters) - As California marked its second day of a new fiscal year without a budget agreement, the state government moved ahead on Thursday to issue billions of dollars in “IOUs” in order to avoid a cash crisis.

SEIU union members and state workers protest outside the State Capitol in Sacramento, July 1, 2009. REUTERS/Max Whittaker

California faces a financial stranglehold after lawmakers failed to balance the budget by the start of the state’s new fiscal year on Wednesday, leaving a $26.3 billion deficit.

Governor Arnold Schwarzenegger, a Republican who declared a fiscal emergency to force lawmakers to tackle the financial crisis, minced no words on Thursday in lambasting lawmakers for their failure.

“In four weeks, in the last four weeks, instead of negotiating and coming to a budget agreement, they decided to debate and to debate and to have hearings and more debates and more hearings and finger-pointing and assigning blame. At the end of the day, they haven’t accomplished anything,” Schwarzenegger said at a press conference in Los Angeles.

Senate President Pro Tem Darrell Steinberg said state leaders need to cool their heated rhetoric of recent days and that he would work with other top lawmakers over the weekend to narrow differences over balancing the budget.

Democrats who control the legislature cannot pass a budget on their own. They agree with Republicans that deep spending cuts are needed but want some taxes increased. Republicans are holding firm against tax increases and Schwarzenegger has sided with them.

“In my view we’re making significant progress,” Steinberg told reporters in the state capital of Sacramento. “It’s time that we get this done.”

California’s finances have been battered by the recession, rising unemployment -- which hit 11.5 percent in May -- and the lengthy housing downturn.

NO CHECKS IN THE MAIL

Under California’s plan to issue IOUs in lieu of paying some bills immediately, finance officials in Sacramento approved paying interest on the IOUs at a rate of 3.75 percent.

Controller John Chiang plans to issue $3.36 billion in IOUs this month so the state has cash for $10.9 billion for priority payments, including money owed to investors holding state debt.

“IOUs are a sign that the state is being fiscally mismanaged,” Chiang said. “That clearly creates implications for further downgrades of California credit ratings.”

The state agreed to redeem the IOUs, technically registered warrants, beginning on October 2.

The first tranche of IOUs will go mainly to taxpayers who are owed tax refunds. “We anticipate printing about 28,742 registered warrants today worth about $53.3 million,” said Chiang spokesman Jacob Roper.

Companies doing business with the state, local agencies and individuals on financial aid such as the disabled, elderly and college students could be in line for the IOUs, raising uncertainty amid already worrisome economic conditions.

“We don’t really know exactly what’s going to come out of this,” said Art McCoy, owner of French Fry Xpress, a Milpitas, California firm that delivers food products to state prisons.

Bank of America and Wells Fargo will accept the warrants, which Chiang’s office planned to begin processing immediately on Thursday.

Slideshow ( 4 images )

The U.S. Federal Reserve on Thursday advised people receiving IOUs from California to check with their banks about possible fees or delays in receiving funds.

The Fed warned the warrants will not be subject to the normal, federal check-hold limits and could be subject to extended holds.

The U.S. central bank also warned that because California will likely return unpaid any registered warrants it receives before the payment date, depositors of the warrants may be subject to returned-deposit fees if their banks attempt to collect these warrants before they are payable. If customers rely on these funds to make other payments, they may be subject to overdraft or bounced-check fees if warrants are returned.

REASSURING WALL STREET

California’s finance officials are aiming to reassure the municipal debt market in anticipation of having to sell up to

$9 billion in short-term debt after a budget is approved.

But Wall Street has its doubts.

“Absent a credible budget revision package, we believe the state may suffer insufficient investor confidence in its finances to successfully place such an offering,” Standard & Poor’s said on Wednesday.

S&P also warned that if California’s budget is not settled soon, the state’s A-credit rating, already the lowest of any of the 50 states, is at risk of falling.

State Treasurer Bill Lockyer’s office is pessimistic it will be able to sell short-term revenue anticipation notes (RANs) for state cash-flow needs as it had planned because of the budget turmoil. Revenue anticipation warrants remain an option, but would be more expensive for the state.

“We’re exploring a variety of avenues to increase the potential market for our short-term cash-flow borrowing,” Lockyer spokesman Tom Dresslar said. “The way the fiscal picture looks at this time, RANs do not look likely.”