World's 8th Largest Economy Can't Pay Its Bills
Just when you thought it was hard enough with lack of access to bank loans, some small businesses in California that contract with the state are being paid for their services in IOUs instead of liquid funds. Owing to a $26.3 billion budget deficit, and the apparent inability of lawmakers to agree to spending cuts or tax hikes, the state does not have sufficient cash to cover all of its payments. I have spoken with small business owners in California that contract to provide goods and services to the state and cash flow pressures in the summer months are nothing new. The California Legislature has rarely met its own June 30 budget deadline, with the result that the state is often in arrears in making scheduled payments to contractors over the summer months. However, this is the first time since 1992 that California has printed IOUs against certain of its obligations. State Controller John Chiang has stated that he will issue $3.3 billion in IOUs along with $11 billion in regular cash payments. Remember, California is the world’s eighth largest economy.
California’s cash flow problems may be disproportionately shouldered by small businesses. When California last issued IOUs for payments, state employees litigated their claims that receiving their paychecks in scrip constituted a violation of the Fair Labor Standards Act. A federal judge agreed, and the workers received their cash payments plus extra vacation time. So state employees will not receive IOUs for their paychecks this time. And, because the federal government is paying certain of California’s social service obligations to the elderly and disabled, they will not be affected by the lack of cash. Governor Schwarzenegger reached out to financial institutions to urge them to accept the IOUs, called individual registered warrants, which will be redeemable by October at a 3.75% interest rate. Wells Fargo, Bank of America and Chase Bank have announced that they will accept the IOUs from existing customers through July 10. It is not clear what will happen after July 10 or what other institutions will do.
In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition, paperback, 2009), I presented a framework for which the California liquidity crisis would qualify as a third-party service failure. Small businesses that depend on clients, such as California, to make timely payments to fund their own obligations are at risk for failure to diversify their client base, just as you would with a vendor or service provider. I am sympathetic to the start-ups in that state, as the market there is brutal.