The Goobernator Strikes Back

Bloomberg reports: California May Pay With IOUs for Second Time Since Depression.

California, the world’s eighth largest economy, may pay vendors with IOUs for only the second time since the Great Depression, State Finance Director Mike Genest said.

Governor Arnold Schwarzenegger warned that he may issue the warrants, which are a promise to pay with interest, to suppliers and contractors as the seizure in credit markets may make it too costly to borrow.

The warrants would be given to landscapers, carpet cleaners, construction firms, food services companies and other state vendors. They would pay an interest rate of as much as 5 percent, based on state law.

This is technically a form of default.

If the true cost of borrowing in the free market is 10% and you're paying them with 5% warrants, you're basically playing a rigged game.

If the contractors try to sell the warrants on the free market, and sure enough, a market will open up for these securities, they will be discounted by precisely the amount needed so that the warrants yield the free market rate. Basically, the contractors will be stiffed by roughly 5% (given above assumptions.)

Of course, the said people might not be too happy about that, and might just stiff you in other (unseen) ways.

Let us know whether that works out for you!