Friday, July 3, 2009

The last time California issued IOUs, Gray Davis was the state controller who made the controversial call. It was 1992 and such a drastic step hadn't been taken since the Great Depression.

Two years later, Davis was elected lieutenant governor and in 1998, governor. In 2003, a year after winning re-election, he was ousted in a recall campaign by Arnold Schwarzenegger, who promised voters he would fix the state's broken finances. At the time, he criticized the budget Davis had signed as having "more special effects than 'Terminator III.' "

So, what does Davis, 66, have to say about the current state of affairs in Sacramento?

The former governor told The Chronicle he is "thrilled" not to be in Sacramento as state leaders try to break a stalemate over California's finances. "I've seen this movie before," Davis said.

Now working for the Loeb & Loeb law firm in Los Angeles and a senior fellow at UCLA's School of Public Affairs, Davis thinks state Controller John Chiang made the right decision to issue IOUs, officially called registered warrants.

What is critical, he said, is for banks to accept the notes. The 1992 budget stalemate lasted 64 days, and the state issued IOUs throughout that period. We talked to Davis by phone this week. His responses have been edited for space and clarity.

Q: How does the situation in Sacramento today compare to 1992?

A: In both cases there is a failure to reach agreement on the part of the governor and Legislature. There was definitely one big difference: In 1992, Bank of America was by far the biggest bank in California. We were able to work with their people and encourage them to accept IOUs. ... Once Bank of America got on board, then most other banks, not all, agreed to accept registered warrants for at a least a limited period of time. The primary difference is we no longer have one clear bank that determines what other banks do in California, and the banking situation is more precarious today.

Q: Why did you think it necessary to issue IOUs?

A: The controller has the obligation to notify the governor and legislative leaders when there is insufficient cash to meet current obligations. The controller doesn't make policy, but he does control state disbursements.

Q: Was it a tough call?

A: No. Because remember, without a budget there are lots of people you can't pay - vendors, people who sell food to the state, people who supply gas for Caltrans equipment. Those people get nothing. Once I was assured that banks would in fact honor registered warrants at least two or three weeks, I felt getting a registered warrant was effectively getting cash and getting cash is better than nothing.

Q: What were the consequences of that? Were there long-term impacts on California?

A: Issuing IOUs is never a good thing. The question is, is it better than doing nothing? In my judgment it is better than doing nothing if most financial institutions accept registered warrants as cash. As a general rule, you don't want to issue registered warrants. It reflects poorly on the state, it will drive down credit ratings in the short term and makes us the laughingstock in some portions of the country.

But is it the end of the world? No. It can be done without long-term consequences depending on the banks.

Q: Are we going through the worst financial crisis in the history of the state?

A: If you just look at the sheer dollar amount of the deficit, the numbers speak for themselves. I think the numbers suggest the largest challenge the state has had to face since the Great Depression, and they indicate how badly the economy has deteriorated.

Q: Do you think the 2003 recall of you as governor has played any part in getting the state to this point?

A: (Long pause). Every governor is faced with an economic challenge if they serve long enough. ... It's hard for me to know what role the recall played. Clearly, the fiscal management of the state was an issue in the campaign, but I stand by what I did. We reduced taxes overall and created jobs. (Schwarzenegger) faces a much more severe economic crisis than I did. Nobody seems to understand that the economy is like the tide. When you're in high tide no one thinks low tide is coming. Sometimes a crisis requires people to rethink how we got in this mess. That's a healthy process.

Q: It seems ironic at the least that fiscal management was a theme of the recall campaign and now it's like deja vu. How do you feel about that?

A: I never believed in pointing fingers, even when in office and I'm certainly not going to do it now. The public and the people in Sacramento need to realize that what they fund depends on revenues coming from the economy and the economy is going to have ups and downs. Not to take that fluctuation into account when making one-, two- or five-year plans is ridiculous.

You have to keep your eye on how the overall economy is going and not just whether ends meet in the current year. It's a totally foreign concept in the Democratic Party; they just think the economy happens.

Q: How much worse do you think California's fiscal crisis will get?

A: There is no question California is being severely challenged. I think relatively shortly the Legislature and governor will rise to the challenge. Could it get worse? Yes. Will it? I don't think so. Why I say that is I think most financial institutions will cash IOUs for a while. ... The moment they stop taking IOUs is the moment the Legislature will have to act or else everything will end up being chaotic.

Q: Do you miss Sacramento?

A: I miss the opportunity to try and help California be better than it is and occasionally you have those opportunities. Do I miss the downside of the job, dealing with the state's problems in difficult times? No. I told (Schwarzenegger) that to be successful you need two things: rain in the north and a strong economy. If you have a strong economy you're a hero and if you don't you're a bum. People want to personalize things; a governor gets credit he doesn't deserve and blame he doesn't deserve. When people are mad they want someone to blame and when people are happy they want to give someone credit. If you understand that about politics, that's all you need to know.