IOU? . . . No You Don’t
Posted by Larry Doyle on July 7, 2009 11:00 AM |
They may make nice bathroom wallpaper, but major banks have no interest in continuing to accept California’s IOUs. The Wall Street Journal highlights this pathetic fiscal folly in writing, Big Banks Don’t Want California’s IOUs.
These IOUs, respectfully designated as warrants, will pay a rate of 3.75% and mature in early October if financial institutions choose not to redeem them. The statement by the major Wall Street banks speaks volumes. What are they saying?
1. They have no confidence in the California legislature to start putting their fiscal house in order.
2. They have no reason to believe Uncle Sam will step in to bailout California as that would open the door for 49 other wayward ‘children’ to march on Washington looking for the same handout.
3. They do not believe the rate of 3.75% properly prices the risk, especially relative to other opportunities to allocate capital.
If these large banks are not willing to accept the IOUs, then why should any individual? I wouldn’t.
Where is this situation headed? I think we can get a strong hint of the direction this situation is headed from an article I posted in the Newsworthy tab here at Sense on Cents. This article from The Washington Post, States Straining to Repair Budgets, highlights that:
The Obama administration has studied several Capitol Hill proposals to help the states but has decided not to move forward on any of them, according to an authoritative government source who spoke on the condition of anonymity because no announcement has been made about the discussions, which were private. One idea was to let struggling local governments borrow at lower rates from the municipal bond market.
Lower rates from the municipal bond market? What? Do you think California would be issuing IOUs if they could tap longer term financing via the municipal bond market? I seriously doubt California could successfully place longer term debt at anything resembling a reasonable rate of interest.
Then just what does the administration mean about “letting struggling local governments borrow from the municipal bond market?”
With short term interest rates on CDs, Treasury bills, and money market funds so excessively low, do not be surprised to see municipalities across the land trying to lure funds via issuing x-Tender securities covered up in municipal money market funds.
For regular readers here at Sense on Cents, you know that I believe these x-Tender securities (municipal auction-rate securities) represent significant risk. Prior to purchasing a municipal money market fund, please review my post entitled “Municipal Money Market Funds: Caveat Emptor.”