California budget shortfall seen nearing $42 billion

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By Jim Christie

SAN FRANCISCO (Reuters) - California faces a $41.8 billion shortfall for its combined current and next fiscal years, up from a prior $28 billion estimate as its economy weakens and revenues decline, the director of the state's Department of Finance, said on Thursday.

Michael Genest, also Gov. Arnold Schwarzenegger's state budget architect, told reporters at a briefing in the state capital of Sacramento the revised shortfall estimate includes provisions for a $2 billion reserve and affirmed the governor's outlook on the state's dwindling cash.

Schwarzenegger said on Wednesday that California's budget deficit for its current fiscal year had widened to $14.8 billion from a previous estimate of $11.2 billion, and the government of the most populous U.S. state may be out of cash by the end of February.

"California faces a growing financial crisis," the Republican governor said, urging the state's Democrat-led legislature to close the current fiscal year's budget shortfall.

"If we don't put aside our ideological differences and negotiate and solve this problem we are heading toward a financial Armageddon," Schwarzenegger said.

He has urged lawmakers to balance the state's budget with deep spending cuts and new revenues, including revenues from increasing the state's sales tax.

After meeting with Schwarzenegger and other top lawmakers on Thursday, state Assembly Speaker Karen Bass told reporters the state's financial situation is dire.

"The fact is we're running out of cash today," she said.

A UCLA Anderson Forecast report released on Thursday underscored the near-term prospects for California's economy, the world's eighth largest, and the state's revenues are grim.

The economic forecasting unit's report said unemployment in California will rise in the first three quarters of next year and the state's economy could weaken further if the financial sector's troubles worsen.

"If the parade of implosions on Wall Street continues, credit market conditions could create a worse downturn in California," the report said.

"The California economy is in for a rough ride in 2009," said Jerry Nickelsburg, the economist who wrote the report. "It's going to be a reasonably deep recession."

Standard & Poor's Ratings Services late on Wednesday expressed its concern about California's financial condition by lowering its rating on the state's recently issued $5 billion revenue anticipation notes.

S&P also placed $46.6 billion of the state's general obligation debt on negative credit watch for a possible downgrade, reflecting concern over the weakening finances of the biggest issuer of U.S. public debt.

California's general obligation debt rating is paired with Louisiana's at the bottom of Wall Street's state rankings. Standard & Poor's and Fitch Ratings currently have 'A+' ratings on the debt, while Moody's Investors Service has an 'A1' rating on the bonds.

(Additional reporting by Jenny O'Mara in Sacramento, California; editing by Carol Bishopric)

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