When a state or city runs out of money, how does it pay its key suppliers and vendors? The issue is becoming top of mind now that many places face falling tax bases and lack of access to credit markets to sell municipal bonds.

In California, the answer may be IOUs. The state may not be able to pay the company that cleans the capitol building or the car company which supplies vehicles to the state police.

Welcome to the new economy and another horror for the business world. According to Bloomberg, "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. " The state has an $11 billion deficit.

Most vendors can't sue the state for the money. Even if they could legally take their cases to court, how many have the cash to face a protracted legal battle?

What it means is that California is cutting its own throat, whether it wants to or not. Some companies doing work for the state need the money. A piece of paper won't let them make payroll. Those firms will fold. When they do, unemployment in the state will continue to move up. That creates a need for more social services for the people without jobs. It means fewer people and companies to pay taxes.

It is a cycle which could take California to the brink of receivership or a federal bailout all its own. When the largest state in American needs that kind of help, the recession really has gotten out of hand.

Douglas A. McIntyre is an editor at 247wallst.com.