May 20 (Bloomberg) -- California is on the verge of running out of cash for the second time this year after a ballot measure defeat yesterday added $6 billion to the budget deficit of the most-populous U.S. state.

Voters yesterday struck down five measures backed by Governor Arnold Schwarzenegger, a Republican, and the Democrat- led Legislature that were intended to shore up the state’s finances. With the governor expecting California to have $21 billion less than it needs over the next 13 months, he has proposed cutting deeper into spending on everything from schools to jails as the state prepares to borrow record sums from investors.

“We have to recognize that and move forward and make all of the changes through cuts,” Schwarzenegger told reporters in Washington today. “We will always represent the people. We will make those cuts and balance the budget through those cuts.”

California is among the states hardest hit by the worst recession in more than half a century, which has caused tax collections to tumble faster than politicians can respond. The depth of the problem was underscored when MDA DataQuick reported yesterday that Southern California house and condominium prices fell 36 percent in April from a year earlier, with foreclosures accounting for more than half of all sales.

The ballot measures’ defeat paves the way for the renewed fight over the budget -- three months after a previous showdown ended when Schwarzenegger broke with fellow Republicans by agreeing to raise taxes and endorse the ballot measures.

Defeated Plan

The package would have extended a $16 billion tax increase for two years, raised $5 billion by borrowing against the lottery, and shifted money from voter-approved programs to the state’s discretionary budget. The only measure to pass was a ban on lawmaker pay raises during financial crises.

The proposals, arranged behind closed doors during an all- night session of the Legislature in February, drew opposition from tax-increase foes and those fearing further cutbacks. The outcome may fuel the divide between Republicans and Democrats that Schwarzenegger sought to bridge, since both can claim victory.

“Everyone is going to extrapolate from the defeat of these initiatives exactly what suits their ideological purposes,” said Dan Schnur, a former Republican consultant who now runs a political institute at the University of Southern California in Los Angeles. “It becomes that much harder to put together working coalitions, particularly on issues such as this.”

Budget Fights

Fights over California’s annual spending plan may frequently erupt because it takes a two-thirds vote to pass a budget. The state’s persistent deficits, and the political difficulty of erasing them, helped California get the lowest credit rating among U.S. states.

The three major credit-rating companies, citing the magnitude of California’s deficits, reduced the grades on more than $46 billion of bonds in February and March. California’s full faith and credit pledge is rated A by Standard & Poor’s and an equivalent A2 by Moody’s Investors Service, five steps below the top investment ranking.

The state has little time for delay. In statements last night, those who backed the measures -- including Republicans who bucked others in their party -- vowed to move quickly to address California’s problems.

‘Get to Work’

“The voters have spoken and they are telling us that government should do the best it can with the money it has,” said Senate President Pro Tem Darrell Steinberg, a Democrat from Sacramento. “We will immediately and responsibly get to work to balance the budget.”

Senator Dennis Hollingsworth, the Republican leader, said his party will soon advance its own budget plan. “With this election, the people of California have sent a clear message to Sacramento,” he said in a statement. “They know that their government has failed them. They have lost confidence in government to fix the budget or the problems they face every day.”

According to the state Legislative Analyst’s Office, the state may run through its cash as soon as July. That would force the controller to shut off some payments, as he did in February, unless California can raise money from investors. The Legislative Analyst’s Office estimates the state may need to borrow as much as $23 billion of one or two-year notes, absent further spending cuts.

Controller John Chiang, a Democrat, said the governor and lawmakers need to move swiftly because one option he employed earlier this year -- delaying income tax refunds -- won’t be available this summer.

“They have to take action now,” he said. “At this point, we have fewer tools in the toolkit.”

Short-Term Notes

The state’s battered credit rating prevents it from selling its short-term notes to money-market funds, which demand lower returns than other investors, without some type of insurance guarantee. Treasurer Bill Lockyer has expressed doubt about whether the state may secure those guarantees from banks and sought help from the federal government. Without such a backstop, he said a $15 billion note sale may cost the state as much as $1 billion in fees and interest.

California would have little trouble raising money from investors, said John Flahive, who oversees more than $20 billion in municipal debt at BNY Mellon Wealth Management in Boston. However, he estimated that the state may pay as much as 3 percent on the notes, more than three times what it would pay if it might sell into money market funds.

‘Enough Demand’

“I believe there is demand enough to do it,” Flahive said. “It’s just a question of how much yield, how much interest cost it’s going to take.”

Much will depend on what kind of plan the state advances to assure investors they will be repaid, he said. “You want assurance they are not going to get into a complete political stalemate.”

A California bond maturing in 2037 traded for as much as 94.72 cents for every $1 face value to yield 5.37 percent today, up from as little as 80.40 cents on Dec. 29.

On May 14, Schwarzenegger introduced his own proposals for eliminating the budget gap, including the deeper cuts that will result from last night’s vote. Among the plans are ones to deport undocumented immigrants in the state’s jails, increase income tax withholdings, cut more from schools and borrow some $2 billion of property tax revenue from local governments in the state.

Richard Robinson, the chief executive of Stanislaus County, a swath of farm land in the Central Valley battered by home foreclosures, said the proposals have upended his own budget plans. The county may be squeezed particularly hard by proposed cuts to state funding on in-home health services for the elderly upon which about 6,100 rely, he said. Any proposals will have to pass through the Legislature.

“All we know is that we won’t walk away from this unscathed,” Robinson said.

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.

Last Updated: May 20, 2009 14:25 EDT