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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.”

LD

  • TeakWoodKite

    LD With the Feds crowding out with massive auctions, does this not make life even more difficult for states to sell paper?

    California is in the hole now for years and and every year the state has stripped more funding away from the local municipalities to offset its own books. Well the the locals are or will be broke in short order.

  • TWK…no doubt. Uncle Sam’s funding needs has pressured rates across all other sectors…not that anybody in Washington would ever admit that…if they understood.

    I will bet that California and other states try to issue these x-Tender securities at a 4% money market rate. People will not fully appreciate that they are not truly investing in a money market fund but more likely an intermediate to longer term bond.

  • divvytrader

    c’mon LD …… just like they announced today that the evil free loading rich will pay the tab for 40+ million new uninsured americans to pile in and share your doctors ( http://www.bloomberg.com/apps/news?pid=20601087&sid=a3wUXb42NPX0 ) , CA and NY and CT too will simply tack on a nice 5-10% surrcharge on you to pay the tab ….. hey , paying 75% out in taxes is patriotic and if you disagree , Rahm Emanuel and a dozen buses of ACORN goons will be at your house pronto

  • Divvy….and that pretty much covers it.

    As soon as we can all appreciate that approach, we can all stop worrying about it.

    Who do you like in the game tonight? (lol)

    Visit often!!






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