Granholm said California officials told her budget constraints prevented them from paying Michigan to house its inmates, the Detroit Free Press reported.
In a letter sent to Michigan's corrections director, California's prison chief Patricia Caruso said the price Michigan was asking for inmates at the Standish Maximum Correctional Facility was too high, and the security at the site was too low.
"I was very disappointed; the discussions we had were very constructive," Granholm said. "I believe we will find another use for that facility, and keep those jobs in the area."
Standish prison, pegged to be shuttered to help Michigan close its $2.7 billion budget gap, also has been mentioned by federal officials as one of two sites under consideration to receive detainees from the military prison in Guantanamo Bay, Cuba, when that facility closes next year.
Granholm has expressed reservations about housing terror suspects because of the security risk they would pose, the Free Press said.
She said discussions are ongoing with Pennsylvania corrections officials about housing some of their inmates, and with the federal government to house federal prisoners.