August 4, 1992
"Limping State has UsedCrutch of IOUs Before"
San Jose Mercury News
By Timothy Taylor
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"REGISTERED warrant" is the official way of spelling "IOU." The state has now used warrants to pay about $1.6 billion worth of bills. The last time it took such a step was during the Great Depression.

But the registered warrants of the 1930s involved much more than a few months of stubbornness in Sacramento. After the state began issuing warrants in November 1933, the last one wasn't paid off until February 1942.

Of course, no one planned on the IOUs stretching out that long. State Controller Ray L. Riley originally predicted that the warrants would be paid off by August 1934.

The Blame Game
Gov. James Rolph Jr. blamed the Legislature. "Everyone in the state government knew," said Rolph in the Los Angeles Times of November 1, 1933, "when the Legislature failed to provide the funds to meet the expenditures allowed in the budget there was no other alternative than to meet the situation as we found it -- by registered warrants."

But Riley's prediction of a rapid resolution to the budget crisis was way off. And Gov. Pete Wilson might note that the blame-the-Legislature strategy didn't fly; Frank Merriam was soon elected governor.

Of course, California's budget situation during the Great Depression differed considerably from today. After all, several states and many cities issued registered warrants during the 1930s, for this was Depression with a capital "D," of the sort that makes the current economic slowdown look like robust economic health. Total personal income in the state of California fell from $5.5 billion in 1929 to only $3.2 billion in 1932, according to figures compiled in California's first Statistical Abstract, in 1958.

The state government did a lot less back then, too. During the late 1980s and early 1990s, the state government has spent about $8 for every $100 of California personal income. Back in 1933, when state programs for health care, welfare and higher education were only infants, state government spent just $3 of every $100 in personal income.

But the most interesting feature of California's Depression- era warrants was how they took on a life of their own. In November 1934, as it became clear that the predictions of paying off the warrants quickly wouldn't hold up, Controller Ray Riley reported to Gov. Merriam that the state budget deficit "will be taken care of within the next two or three years."

That forecast looked good by the summer of 1937. As the California and national economies rebounded, tax revenue rose faster than expenses, the state budget was in surplus, and the balance of registered warrants outstanding fell from about $35 million in early 1937 to less than $10 million in August and September of that year.

But a more subtle change had taken place, too; warrants had become an integral part of how the state did business. Harry B. Riley, who was to serve as state controller from his election in January 1937 until his death in February 1946, recorded in his first biennial report to Gov. Merriam how the state had dealt with the logistical problems of using registered warrants to make unemployment payments to individuals.

"If these payments were made by individual registered warrants," Riley explained,"the expense of handling them by the banks would probably more than equal the interest to be earned. The practical solution was therefore to issue large denomination warrants to cover bills on hand, sell the warrants, and pay the bills from the proceeds of the sales."

In short, a market formed in buying and selling large- denomination warrants during the mid-1930s. It remains true today that selling a few large warrants would reduce the handling costs dramatically, and save individuals from having to find a bank that will take the warrants.

But then the recession of 1937-'38 hit, creating new budget problems. In his biennial report to new Gov. Culbert Olsen in January 1938, Controller Riley described the problem in terms that should have a familiar ring in Sacramento today:

"Many of the governmental services and aids which are forcing increased expenditures on the state have been written into the Constitution and the statutes by the people and the Legislature in such a manner that without further legislative initiative there is no immediate escape from the payment of ever-increasing amounts." He pointed out that unemployment relief payments, for example, doubled from 1937 to 1940.

But the financial market was now ready for a new wave of registered warrants. By July 1940, an all-time high of $98 million in warrants was outstanding, equal to about half of general fund state spending that year. For comparison, half of this year's general fund spending would be about $20 billion.

The Depression-era registered warrants were not ended by resolute state action. In 1943, Riley wrote to yet another governor, Earl Warren:

"Long before Pearl Harbor, it had become apparent that California was fast becoming the keystone in the edifice of American war-industry. With gigantic shipbuilding, Army and Navy air bases and other projects in view or under way, and with the daily awarding to California concerns of government contracts involving unprecedented outlays of capital, this state had already begun to feel the effects of an incipient industrial boom."

A defense buildup allowed paying off the last of the warrants in early 1942. But the decline in defense spending in the 1990s has added to the sting of recession in California, helping set the stage for issuing today's round of registered warrants.

Unlikely but Workable
It seems extremely unlikely, in August 1992, that the latest round of IOUs will last much longer. But it also seemed unlikely that warrants would be issued in the first place, or that they would drag on into August. Many banks have now set up systems for dealing with the warrants (even those banks that are now turning down the IOUs). California politicians have now learned that IOUs are a workable option.

The California budget deadlock is more than just bull- headedness in Sacramento; there is a basic disjunction between the level of government services Californians favor and the level of taxes they are willing to pay. Now that warrants have been introduced, don't be surprised if they keep popping up as a possibility, as long as the underlying imbalance in the budget remains.

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