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SACRAMENTO (CBS 5 / AP) ― Gov. Arnold Schwarzenegger on Wednesday declared a fiscal emergency to address California's budget crisis and ordered state offices closed three days a month to save cash, after lawmakers failed to close the state's worsening deficit.

Meantime, California's controller was poised start paying many of the state's bills with IOUs as soon as Thursday, adding a new measure of indignity to the state's sinking deeper into dysfunction.

Controller John Chiang said his office was prepared to issue IOUs totaling $3.3 billion in July.

Lawmakers' failure to act on Tuesday, the end of the fiscal year, also widened California's deficit from what already had been a whopping $24.3 billion more than a quarter of its general fund. The shortfall grew by $2 billion overnight, in large part because of the state's highly complex funding formula that boosts school funding each year.

The failure to balance the state's main checkbook and the looming IOUs was what Schwarzenegger said prompted him to declare the fiscal state of emergency.

"California needed the Legislature to act boldly and with conviction. Their response was not a solution to California's budget problem but an invitation to actually a bigger financial crisis," Schwarzenegger told reporters.

Under the declaration, if the Legislature fails to solve the deficit within 45 days, it cannot adjourn or act on any other bills until the fiscal crisis is resolved.

The partial government shutdown being implemented also will lead to a third furlough day for 235,000 state employees, bringing their total pay cut this year to about 14 percent.

A state employee union that represents engineers immediately said it would sue to stop Schwarzenegger's latest furlough order. The Professional Engineers in California Government already sued over Schwarzenegger's previous furlough orders.

As the previous fiscal year was drawing to a close, the state Senate rejected three bills designed to save $5 billion, including $3.3 billion in education funding cuts that had to be enacted by Tuesday. Passing those bills would have given the Legislature time to work out a broader solution to the deficit and delayed the need for IOUs and more furloughs.

Instead, the budget shortfall is set to grow even wider because of California's complicated school funding formula, meaning the state will not have enough money to pay all its bills.

Senate President Pro Tem Darrell Steinberg, D-Sacramento, accused Republicans of holding the state hostage by not voting to accept the $3.3 billion in immediate savings that would have avoided IOUs.

"This is craziness. There's no excuse for it," the Senate leader said.

Senate Minority Leader Dennis Hollingsworth responded by claiming that neither he nor his Republican colleagues wanted to see California resort to IOUs to pay its bills, but he said Democrats had refused to make sufficient spending cuts to solve the shortfall.

"It's unfortunate that we're at this point," said Hollingsworth, R-Temecula.

It will be the first time since 1992 that California will have issued IOUs. The move is almost certain to further damage the state's credit rating, already the lowest of any state, saddling taxpayers with billions of dollars in higher interest payments on bonds that have yet to be sold.

Issuing IOUs formally referred to as individual registered warrants also will have real-world consequences for those on the receiving end. Small businesses that rely on state contracts will be most affected.

"It really doesn't affect the million-dollar companies. It's the smaller ones that will get hit," said Paul Nguyen, director of Care Now Staffing, a Southern California company that employs a dozen medical professionals.

The family owned company, based in Alhambra, has about 10 weeks of payroll in reserve, but Nguyen said he would be forced to lay off employees and close if the budget crisis stretches into September.

The IOUs also will be sent to California counties, which now must find other ways to fund a wide array of social programs, ranging from alcohol abuse and mental health treatment to services for the elderly and disabled. California's universities were evaluating ways to assist students whose grants will not be funded to pay education expenses.

It was unclear whether some of California's largest banks will accept the state's IOUs as payment. They would be paid back, with interest, but the state's precarious financial condition and legislative gridlock might be making some bankers nervous.

Bank of America announced Wednesday it would cash the IOUs for its customers through July 10, bank spokeswoman Colleen Haggerty said. Schwarzenegger and state officials asked other banks to do the same, noting that California has never defaulted.

"We will make those payments," he said. "We are responsible."

Shavila Singh, president of an environmental services company in Southern California, said she was unsure whether her bank would loan her the money to keep all of her 100 employees on the payroll.

If her bank does not give her a loan or cash the state's IOUs, she predicts she might have to lay off between 20 and 30 workers.

"We have options to pursue, but everything is so unclear," said Singh, president of Zero Waste Solutions Inc. in Newark. "I don't know how much the bank will be able to cover."

The IOUs are necessary because California doesn't have enough incoming tax revenue to meet all its payment obligations. If the budget impasse drags into August, the state would have to issue another $4 billion in IOUs.

The warrants are only a temporary fix to the state's cash-flow crisis. By September, the state will be $600 million in the red if lawmakers do not figure out a way to balance the budget, according to the controller's office. That's the point at which California runs the risk of insolvency.

The state is constitutionally required to pay schools and bond holders first. State employees, retirees and businesses that provide Medi-Cal and In-Home Supportive Services also must be paid in cash.

Nearly a third of the state's IOUs will target mandatory payments to the disabled, low-income seniors and those enrolled in the state's welfare-to-work programs, but recipients will not see their monthly checks reduced.

That's because the federal government, which sends checks to the disabled and low-income seniors, has pledged to cover California's share, said Garin Casaleggio, a spokesman for the state controller.

Counties also must fully pay checks to welfare recipients or risk being sued, said Jean Hurst, a legislative representative at the California State Association of Counties. That could mean money now dedicated for county parks, libraries and road repairs might be used to pay for welfare and other mandatory entitlement programs.

The California Student Aid Commission will receive about $159 million in IOUs, including funds for Cal Grants to university students.

In the past, California's public universities have paid for grant-funded students when the state has been unable to pay its bills. It's unclear whether colleges will have the money to do that when fall classes begin.

"Things are developing as we speak," said Clara Potes-Fellow, a spokeswoman for the chancellor's office at California State University.

Ricardo Vazquez, a spokesman for the University of California president's office, said the administration would wait another month before making any decisions.

Prospects appeared dim for a quick resolution to the state's fiscal crisis, but lawmakers find themselves under even more pressure after the governor's emergency declaration and with the IOUs ready to be sent. 

"The IOUs don't solve the budget problem," said Jerry Nickelsburg, a senior economist at the Anderson School of Management at the University of California, Los Angeles. "The IOUs just create uncertainty and disruption, which is negative for the California economy."

(© 2010 CBS Broadcasting Inc. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed. The Associated Press contributed to this report.)