We’re 11 days past the July 1 deadline, and California still doesn’t have a budget in place.

Democratic lawmakers and Republican Gov. Arnold Schwarzenegger remain at loggerheads about a $26 billion budget shortfall. Schwarzenegger says he won’t accept any more taxes.

Without a budget, the state can’t spend money. Without being able to spend money, the risk of default rises.

A default would unleash a cataclysm that would send shock waves through an already tenuous stock market. California’s bonds have already lost some of their luster: Fitch cut its rating to “BBB” this week, two notches above junk status.

If the bonds are downgraded to junk, either in advance of or after a missed interest payment, for example, large holders like pension funds would be forced to sell their bonds, and at fire-sale prices.

The conventional wisdom is legislators will settle the matter before the state defaults on its bonds. In fact, the probability of default is 26.7%, according to the credit-default swap market. That risk has sent California’s bonds falling, and when prices fall, yields go up.

The interest California pays bondholders is exempt from federal taxes. That has pushed up the bonds’ rate of return to a tax-equivalent yield of nearly 10%.

The state’s treasurer has started issuing IOUs, or “scrip,” in lieu of cash. This has forced the state’s community banks into financing the impasse. They have to deposit the IOUs into customer accounts and treat them as cash, or risk losing customers, which they can ill afford. The nation’s large banks, which can afford to lose customers, have said they won’t take any more IOUs after Friday, July 10. Rather than collecting the 3.75% in interest the IOUs carry, the banks have said they will loosen credit to customers that have been paid in IOUs — and earn the higher rates on those loans.

California plans to pay back the IOUs in October. In the meantime, the SEC has ruled that they are subject to the same rules as other municipal bonds, meaning anyone wanting to act as an intermediary between buyers and sellers of California IOUs must be a registered broker/dealer. These requirements have chilled the secondary market for California IOUs, making it even harder for Californians to cash them in. Even so, a lot of these securities are trading on Craigslist, and at deep discounts.

The risk of California not paying back its debts was never seriously in question: Such payments are mandated by the state’s constitution for both bonds and IOUs (and states can’t declare bankruptcy). The risk was the bonds being downgraded to junk and losing a significant percentage of their value. But with Governor Schwarzenegger and state legislative leaders now back at the negotiating table and hopeful to reach a resolution within the coming week, that downgrade is looking less and less likely. The budget impasse will be solved — that’s always been a “when” question, not an “if” one.

So for investors seeking tax-efficiency who are comfortable staring down the governor, California’s general-obligation bonds look ever more enticing, with tax-equivalent yields approaching 10%. And you can guess that angry Californians — some of whom are being paid with scrip worth $0.50 on the dollar that some banks won’t even take — will provide Sacramento with the impetus to pass a compromise budget and end the impasse.