California wants federal government to back its loans

SACRAMENTO, Calif. -- If AIG was too big to fail, how about the world's eighth-largest economy?

In a move with only one modern-day precedent, California Gov. Arnold Schwarzenegger and Democratic lawmakers are pressing the Obama administration and members of Congress for federal loan guarantees to help the state out of a multibillion-dollar jam.

California is not asking for cash, like the tens of billions given to AIG, General Motors or Morgan Stanley. Instead, the state with the worst credit rating in the nation is asking that Washington act as a sort of co-signer on the state's borrowing, to be backed up with money from the Troubled Asset Relief Program.

California leaders say that would make it easier and cheaper for the state to borrow money on the bond market, reducing the interest rate by as much as half and saving taxpayers hundreds of millions of dollars.

The Obama administration has responded cautiously to the idea, and members of Congress from other states worry that it would put the federal government in the business of backing municipal bonds -- a job traditionally held by investment banks.

They worry also that the U.S. government could overextend itself and risk its triple-A credit rating if California and other states or cities in distress start coming to Washington hat in hand.

But California leaders warn that without assistance from Washington, the nation's most populous state could fall deeper into a financial abyss and resort to even bigger spending cuts and layoffs, becoming a drag on the economic recovery of the nation as a whole.

"There's simply no better stimulus than guaranteeing state and local bonds, particularly those that are being used to get through the crisis and avoid layoffs," said Rep. Brad Sherman, one of 15 Democrats in California's House delegation who signed a letter earlier this month asking for the federal loan guarantee.

Plus, supporters of the idea note that Washington stands to make a profit from loan fees as it did after bailing out New York City in 1975, a move that brought the city back from the brink of ruin.

Because of a steep drop in tax revenue, Schwarzenegger and lawmakers are struggling with a projected deficit of $24 billion, or more than a quarter of the general fund.

Come this summer, California will need to borrow money simply to pay for day-to-day operations. The state does that routinely every year. But this time, the amount California must borrow is a lot higher. And the tight credit market and questions about California's ability to repay are likely to make borrowing extremely expensive for the state.

"We are not asking for a bailout," said state Assembly Speaker Karen Bass, a Los Angeles Democrat. "We're asking for the federal government to step in where commercial banks can't this year because of the crisis within the financial industry."

So far, no other state has asked for such aid. States such as Arizona and Nevada have proportionately larger deficits than California but do not face the same cash-flow crunch. Michigan is in distress too, but stands to benefit from the Obama administration's rescue of the auto industry.

Treasury Secretary Timothy Geithner told a House committee last week that he did not have authority to use financial rescue money to help state governments. But he did not rule out assistance. He said California's request would have to be decided in Congress.

The idea's prospects in Congress are uncertain. But California has far more clout in Washington than any other state, with the nation's largest congressional delegation and a San Franciscan, Nancy Pelosi, as speaker of the House.

Democratic Rep. Barney Frank of Massachusetts, chairman of the House Committee on Financial Services, said he supports legislation to help California and other cash-strapped cities.

"I think if the federal government can go to the aid of major financial institutions, particularly when state and local governments face short-term liquidity issues, I think helping them out is very relevant," Frank said.

California already has cut $15 billion and raised taxes by nearly $13 billion this year. Schwarzenegger has proposed cutting nearly $20 billion more, including eliminating California's welfare-to-work program and getting rid of health insurance for 930,000 poor children.

Other members of Congress worry about the precedent if the government agrees to guarantee California's borrowing. Rep. Darrell Issa, a California Republican, said other states would be certain to ask for help, too, and he warned that the U.S. government's credit rating could be downgraded as a result.

In 1975, President Gerald Ford rejected a similar plea from New York City, prompting the not-entirely-accurate headline "Ford to City: Drop Dead." With the city on the verge of bankruptcy, the president ultimately relented, signing legislation for federally guaranteed loans. The loans have since been repaid with interest.

California is just as likely to repay its loans, said Matt Fabian, a bond analyst at Municipal Market Advisors, based in Concord, Mass. He and others noted that the state has never been late on a payment, and is always collecting revenue and has the option of raising taxes.

"California's not going to default," Fabian said.

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Associated Press Writer Kevin Freking in Washington contributed to this report.