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By Michael B. Marois and William Selway

Dec. 24 (Bloomberg) — California Governor Arnold Schwarzenegger, anticipating a $21 billion state budget deficit, plans to ask President Barack Obama to ease mandates and minimums on social programs to save as much as $8 billion.

The Republican governor plans to seek the relief, according to a California official who asked not to be identified because details haven’t been resolved. Instead of seeking one-time stimulus money or a bailout, the most-populous U.S. state wants the federal government to reduce mandates and waive rules stipulating expenditures on programs such as indigent health care, the official said.

California is among states most affected by the economic recession. It has the lowest credit rating and recorded the nation’s second-highest rate of home foreclosures, trailing only Nevada. Unemployment peaked at 12.5 percent in October amid the loss of 687,700 jobs from the year before, when the jobless figure was 8 percent. Wealth declined as the stock market lost 40 percent of its value in 2008.

“I’ve seen the reports that Governor Schwarzenegger was specifically looking for aid and it’s something that obviously folks at the White House are taking a look at,” White House spokesman Bill Burton said. He commented to reporters on Air Force One today as the president and his family flew to Hawaii for Christmas vacation.

‘No Easy Solutions’

“The problem is that there are no easy solutions left,” said Jean Ross, executive director of the California Budget Project, a Sacramento-based research group concentrating on issues facing the poor. “Where do you go to cut that doesn’t permanently compromise the level of public services that this state needs to remain economically competitive and to have some semblances of a safety net left for vulnerable populations.”

Schwarzenegger and lawmakers worked to close a record $60 billion gap from February through July with $32 billion in spending cuts, $12.5 billion of temporary tax increases, $8 billion of federal stimulus money and more than $6 billion of other one-time fixes.

California’s deficits show how local governments are being forced to chose between raising taxes or cutting more funding for schools, health care and other programs, even as the economy is emerging from the recession that began in December 2007. The nascent recovery has yet to produce any job gains, a drag on states that rely on income and retail sales taxes.

National Picture

Nationally, 35 states and Puerto Rico expect to have $56 billion less next year than they will need to pay for all of their programs, according to the National Conference of State Legislatures. In Nevada, Arizona and New Jersey, the difference amounts to more than one-quarter of their budgets, the conference said. Funds from the $787 billion federal stimulus bill passed in February run out at the end of next year.

Schwarzenegger, 62, will detail his request for help when he delivers his annual State of the State address on Jan. 6 and unveils his budget on Jan. 8, his last chance to reshape California’s fiscal policies before he leaves office in January 2011 after seven years.

The arsenal of one-time accounting maneuvers he and lawmakers have previously used to temporarily paper over parts of the gap — such as accelerating income-tax collections — has been mostly depleted, making efforts to erase the latest $21 billion deficit more difficult.

Struggling to Cut

The state also has struggled to implement cost-cutting measures that were part of the $85 billion spending plan approved in July. Courts blocked part of the budget that cut funding for home care for the disabled and another part that borrowed $800 million from an account that sets aside money for local transportation agencies.

An accounting error means the state has to spend almost $1 billion more on schools than budgeted. Officials also underestimated the cost of health care for the poor by $900 million, and lawmakers failed to pass legislation to realize $1 billion less in anticipated prison spending.

Combined, the state faces a $6.3 billion gap in the current year and another $14.4 billion in the next.

“We’ve already gone after the low-hanging fruit and the medium-hanging fruit and the higher-hanging fruit, so it’s going to get tougher and tougher now to balance the budget,” Schwarzenegger told reporters in November.

The governor has said he won’t increase taxes again to close the gap. That means more cuts, complicated by mandated expenditures for programs such as Medicaid health-care for low- income residents. With reductions already made to programs for the poor, additional trims jeopardize those federal funds.

Biggest Issuer

“In terms of programmatic reductions, we have to keep an eye on the fact that in some areas — be it education or health and human services — if you run afoul of federal maintenance of efforts requirements, you risk the loss of federal dollars,” said Schwarzenegger’s budget spokesman, H.D. Palmer. “As tough as 2009, these factors are going to make 2010 even more challenging.”

The state was the biggest bond issuer this year, selling $36 billion of debt. It may come to market with at least $5 billion more of public-works obligations in the fiscal year that begins July 1, state Treasurer Bill Lockyer said.

Moody’s Rating

California’s general-obligation debt rating from Moody’s Investors Service is Baa1, the company’s eighth-highest investment grade, and A from Standard & Poor’s, the sixth- highest. By comparison, Greece, the poorest member of the 16- nation euro region, is rated two steps higher at A2 by Moody’s and two lower at BBB+ by S&P.

“California, which is more than three times bigger than Greece, is running out of money,” T.J. Marta, chief market strategist at Marta On The Markets LLC, a financial-research firm in Scotch Plains, New Jersey, told Bloomberg Radio today.

A Standard & Poor’s/Investortools index of California state and local debt has returned 13.1 percent this year through Dec. 23, about 1.5 percentage points less than the national average.

Investors have demanded higher interest rates from California, compared with other borrowers. The state’s 10-year bonds yielded 4.6 percent by the end of last week, 1.51 percentage points more than top-rated municipal borrowers, according to Bloomberg indexes. Three months ago, that difference was as little as 1.06 percentage points. Greek 10- year bonds yield 5.72 percent, Ireland’s 4.78 percent and Spain’s 3.93 percent.

In California, “it’s never a quick budget, it’s always prolonged and when it’s prolonged the headlines get worse and spreads widen,” said Peter Hayes, who oversees $115 billion in municipal bonds for New York-based BlackRock Inc., the world’s largest asset manager.

Opposition to Cuts

Democrats, who control both chambers of the Legislature, are expected to oppose wholesale cuts to health and welfare programs. Such resistance, along with Republican opposition to tax increases, will be exacerbated as election-year politics heightens the partisan divide. Half of the state’s 120 Assembly and Senate seats go before voters in November.

Budgets and tax increases in California must be approved by a two-thirds majority, and Democrats are two votes short in the Senate and six in the Assembly.

“When you are looking at a deficit in the size we have, everything needs to be on the table,” Assembly Speaker-Elect John Perez, a Democrat from Los Angeles, told reporters on Dec. 11. “The reality is that the likelihood of passing taxes in this environment is slim, but everything has to be on the table. We have to come up with a resolution to this budget crisis that asks everyone to sacrifice, not just the people that are in the greatest need.”

To contact the reporters on this story: Michael B. Marois in Sacramento at mmarois@bloomberg.net; William Selway in San Francisco at wselway@bloomberg.net

By COREY BOLES and MARTIN VAUGHAN

WASHINGTON — Congress’s move to lift the federal government’s borrowing limit by $290 billion — enough to last about two months — sets the stage for a contentious debate early next year on government spending.

The Senate on Thursday approved the increase in a 60-39 vote that was largely along party lines. The House passed the measure last week.

The additional $290 billion in borrowing ability lifts the total public debt the federal government can hold to about $12.4 trillion and will allow the government to keep borrowing through February.

Treasury officials had warned that the current limit of $12.1 trillion was close to being breached. Congressional leaders scrambled to raise the ceiling before they began the holiday recess.

An increase in the debt ceiling is largely symbolic as it represents money already spent by the U.S. government. In the unlikely scenario where it was ever breached, however, there would be significant consequences for the financial markets. The federal government would be forced to default on its obligations, and could lose its top credit rating, having to pay much higher interest rates as a result.

Just two weeks ago, several senior Democratic lawmakers had said they were close to reaching an agreement on an increase in the debt limit of $1.8 trillion to $1.9 trillion, enough to support the federal government’s borrowing needs through 2010. That would have avoided the need to take up the issue again next year, when many Democratic lawmakers are expected to face tough re-election battles.

But when it became apparent there wouldn’t be sufficient support in the Senate for that, Democrats scaled back their ambitions and moved forward with the more modest increase.

That leaves Congress facing another debate on the issue before the end of February. Senate Majority Leader Harry Reid (D., Nev.) said this week that would be the first order of business the Senate deals with when lawmakers return Jan. 19.

Republicans are hoping to tap into the public’s anxiety about the federal government’s finances to make gains in the polls next November.

When the Senate takes up the debt issue in January, Republicans plan to hold votes on a number of measures that would seek to restrain the federal government’s ability to spend. These include discretionary spending caps, a move to strip out already-committed funding from the fiscal 2010 budget and the creation of a commission to investigate longer-term solutions to the debt issue.
—Patrick Yoest contributed to this article.

Write to Corey Boles at corey.boles@dowjones.com and Martin Vaughan at martin.vaughan@dowjones.com

Dear Fellow Arizonan,

We face a state fiscal crisis of unparalleled dimension – one that is going to sweep over every single person in this state as well as every business and every family.

That is why I held an emergency cabinet meeting yesterday morning where I outlined for our state’s elected leaders and business leaders the ills our state faces. As I told them yesterday, we ARE faced with some of the worst days in our 97-year history.

We can debate how we got here, but we CANNOT remain paralyzed in our efforts to address the situation. We must set aside partisan politics and face the problem head on.

We must accept that we ARE where we ARE.

So here’s the TRUTH:
· The state has a budget deficit for the current fiscal year of $1.5 billion.
· Next fiscal year, 2011 — a budget year that begins in just six months — is even worse. Next year’s budget deficit stands at $3.4 billion. As of today — right now, that MUST change.

Even though my Administration has already cut $1 Billion in state government spending, we must redouble our efforts to create a leaner, more fiscally responsible Arizona.

I have asked all 90 members in the State Legislature to cooperate by submitting a reasonable plan. On behalf of citizens across our state, I expect them to become active participants in the budget process.

This problem did not happen overnight.
· Five years of spending nearly doubled state government.
· The economic recession has reduced state revenues by almost 40 percent in just 3 years.
· Population growth in school children, university students, health care and welfare populations and inmates in our state prisons has fundamentally ruled out simplistic solutions like rolling the state budget back to levels from five, six, or more years ago.
· Federal and voter mandates prevent us from touching nearly two-thirds of the state budget.
· And procrastination, denial, and lack of will have allowed these problems to fester.

We must solve these problems and we must solve them now. More than calling for cooperation, today I had state government implement various emergency measures meant to ensure Arizona’s fiscal solvency. Among them:
· I ordered the Arizona Department of Corrections to return to the custody of U.S. Immigration and Customs Enforcement (“ICE”) — as soon as possible — all non-violent criminal aliens as is allowed under existing law. These inmates are the responsibility of the federal government (as is securing our border with Mexico). Arizona should not have to bear this cost.
· I am restating my Arizonans-only directives to state agencies to ensure that public benefits are provided only to those who are legally in this country and who reside in this state.
· Effective immediately, I have ordered all state agencies who benefits to citizens to implement means testing and sliding fee schedules. While the government safety net must stay in place, we need to secure help only for the neediest among us.

These measures, though they may represent tough news for many Arizonans, are necessary to keep the state moving forward. Every Arizonan must understand why this state is suffering.

That is why I invite you to take a moment now to visit my Web site to view the presentation I presented today to the state’s elected leaders and business leaders. After viewing this presentation, you will see the desperate times our state faces.

You will also understand why we MUST ACT NOW not as Democrats, Republicans or Independents but as Arizonans.

We owe it to the citizens of this state — our children and grandchildren — to adopt and approve a solution.

Sincerely,

Jan Brewer?
Governor

P.S. Simply go to www.JanBrewer.com/Crisis to view or download your personal copy of the presentation I gave yesterday.