SAN FRANCISCO (Reuters) - California Gov. Arnold Schwarzenegger has told U.S. Treasury Secretary Henry Paulson that the most populous U.S. state may need the federal government to buy $7 billion of debt the state is unable to sell due to weak credit markets- and that California may not be alone.

California Governor Arnold Schwarzenegger in a file photo. REUTERS/Robert Galbraith

The $7 billion issue of revenue anticipation notes would raise cash to tide California over the near term until it gets expected revenues, but the plan to sell the debt is in peril because the municipal debt market is frozen, State Treasurer Bill Lockyer said earlier this week.

“This is not a normal year,” said Lockyer spokesman Tom Dresslar on Friday, adding that the state was preparing the issue but that markets were in turmoil: “The paralysis lingers.”

The municipal bond market, where California hopes to sell its short-term notes, has all but frozen up over the past three weeks as buyers have been scarce and tax-exempt yields have skyrocketed. Few deals have been priced, while scores of issuers such as states, hospitals, school districts and others, have postponed their bond sales awaiting a market turn around.

However, the U.S. House of Representatives on Friday passed a landmark $700 billion financial industry bailout bill, which has been seen as a key to calming market fears around the world.

After the bailout bill’s passage, municipal bond yields began to retreat, indicating improved demand for public debt, which should help issuers.

If the state could not sell the notes, it would have to adopt measures to cut spending, such as delaying salaries of teachers and other state employees.

Lockyer, a Democrat, and Schwarzenegger, a Republican, have warned that California may have to delay payments for essential state services such as law enforcement, and in his letter to Paulson the celebrity governor said his state is not alone.

“Absent a clear resolution to this financial crisis that restores confidence and liquidity to the credit markets, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the Federal Treasury for short-term financing,” Schwarzenegger said in a letter to Paulson dated October 2 and provided to Reuters on Friday.

“The economic fallout from this national credit crisis continues to drain state tax coffers, making it even more difficult to weather the continuation of frozen credit markets for any length of time,” Schwarzenegger said.

Lockyer said on Wednesday the planned note sale was at risk from the uncertainty gripping financial markets. “Basically no credit is available -- zero today,” the treasurer of the biggest U.S. issuer of municipal debt told Reuters in a telephone interview.

He and Schwarzenegger both supported a federal recovery plan ahead of the House vote on Friday.

Many California state officials fear state financial assistance to local governments may be cut while local sales tax and property tax revenues are sagging. Additionally, many are concerned about the financial condition of public pension funds.

The state’s liquidity squeeze weighed on its Congressional delegation. “I can’t recall when that has happened before,” Rep. Dan Lungren, a California Republican said on the floor of the U.S. House. “That ought to give us some pause here.”

Schwarzenegger spokesman Aaron McLear said the Republican governor and Democratic state treasurer are in agreement on California approaching the U.S. government to buy its notes if necessary.

“If we can’t secure these loans through traditional means, which is the RAN market on Wall Street, we may need to try something else, which is essentially asking the federal government,” McLear said. “We can’t pay our bills if we don’t have money ... It would affect all the bills the state is required to pay.”

“If the Congress is unable to act, it’s going to make liquidity in the financial market much more difficult to access,” McLear added.

(Additional reporting by Kevin Krolicki in Washington and Karen Pierog in Chicago)