The financial sector has just delivered a message to California, roughly translated as, “Quit working on cow tails and apologies to long-dead people.”  A group of the largest banks in the US has announced that it will stop accepting California IOUs by Friday.  The state will run out of cash by the end of the month if it cannot issue IOUs, as long as its $24 billion budget gap remains unresolved:

A group of the biggest U.S. banks said they would stop accepting California’s IOUs on Friday, adding pressure on the state to close its $26.3 billion annual budget gap. …

The group of banks included Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co., among others. The banks had previously committed to accepting state IOUs as payment. California plans to issue more than $3 billion of IOUs in July.

Ms. Mills of the CBA said some banks were concerned that there aren’t processes in place to accept IOUs, and also worried about fraud issues.

One of the reasons we use a common currency, provided by the federal government, is to avoid fraud issues.  Several people have wondered at the legality of issuing IOUs as cash devices.  They accuse California of creating currency, which is unconstitutional, although the state has done it on previous occasions.

Also, Californians may not understand this, but these IOUs are essentially state bonds.  The people who buy them are demanding 3.75% interest APR on the devices, which means that the state is actually spending more money than they normally would now.  The longer they use IOUs instead of cash, the more expensive it gets for Californians later when the IOUs get cashed.

Interestingly, all of the above banks have accepted TARP funding, or perhaps more accurately, had TARP funding thrust on them.  Would the Treasury have to have approved this decision?  Did the Treasury insist on this decision?  If so, it could either signal a hardline approach from the White House on California’s budget crisis, or give them an excuse to intervene.

A bailout would only delay the day of reckoning.  California’s budget woes are entirely of their own making, and a bailout would not solve the underlying political problems in California.  They tax too much and they spend too much, and their political class hasn’t got the guts to actually solve either of those problems, let alone both.  A bailout would put California right back in the same place next year, and the year after that.  If ever there was a moment for tough love from Uncle Sam, this is it.