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HomeIOU? . . . No You Don’t
Posted by Larry Doyle on July 7th, 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.”
Hotel California Revisited: Prisoners Here of Our Own Device
Posted by Larry Doyle on May 20th, 2009 4:30 PM |
“Tonight we have heard from the voters and I respect the will of the people who are frustrated with the dysfunction in our budget system,” Gov. Arnold Schwarzenegger said.
The Wall Street Journal provides full coverage, “California Voters Reject Budget Measures.”
What does California’s budget nightmare mean? The state will be forced to cut upwards of $20 billion from an $82 billion budget. How and why? In the face of the the massive recession, California’s tax revenues are insufficient to meet the state’s fiscal needs.
In years past, California and other states would tap the municipal bond market with bond insurance provided by a monoline insurer, such as MBIA or Ambac. Given the enormous losses suffered by these monolines, primarily on structured mortgage deals, they are no longer strong enough to provide insurance sufficient for California to raise funding. In a similar vein, California can no longer source a letter of credit provided by a large money center bank.
Where is California looking for a backstop to its financial woes? Well, much like the United Auto Workers, the strongly Democratic constituencies in California will look toward Washington for a backstop/bailout.
California’s representatives are downplaying the severity of the situation. California Treasurer Bill Lockyer, much like Barney Frank, condescendingly comments on the historically low level of defaults in municipal finance. Do I have to remind Bill and Barney that historical analysis was also highlighted in providing AAA ratings to sub-prime mortgage deals? (more…)
As California’s Economy Goes, So Goes the Country
Posted by Larry Doyle on May 12th, 2009 5:15 PM |
Political hacks assert, “all politics is local.” In a similar vein, armchair economists propose, “as California goes, so goes the country.” Why is that? California represents such an enormous part of our country in many respects, including the following:
– 8 of the 50 largest cities
– population of approximately 37 million people (that we know of), a full 12% of our national population
– an economy similar in size to Italy, ranking it as one of the top 10 in the world (I have seen rankings of 8th and 9th)
– California’s economic output represents 13% of our national GDP!!
– an unemployment rate north of 11% compared to the national average of 8.9%. With a high unemployment rate amongst illegal immigrants, it is not a stretch that California’s unemployment rate is approaching 15% and its underemployment rate is greater than 20%!!
The results of the Bank Stress Tests indicated that Bank of America and Wells Fargo had the greatest capital shortfalls. Why is that? BofA already had a huge market share in California and it grew exponentially with its purchase of Countrywide. Wells Fargo also had huge market share in California and it only grew with its purchase of Wachovia. Hey LD, Wachovia is a North Carolina based bank, how could that correlate into increased California exposure? Wachovia purchased Golden West Financial, a southern California based bank which had been one of the most aggressive lenders of a mortgage product known as pay-option ARMs. Suffice it to say that product has been a disaster in terms of delinquencies, defaults, and foreclosures.
Earlier this year, California faced a massive budget shortfall and experienced significant political turmoil in passing a budget. Well, the Governator Arnold Schwarzenegger is right back in the ring as California’s fiscal situation is faced with more sinkholes. The WSJ reports, Cuts Loom in California if Propositions Fail.
While politics may be local, the economic fallout from California can not be walled off from the rest of the country. The capital cushions that BofA, Wells Fargo, and many other banks are forced to set aside against consumer, corporate, and municipal defaults literally ripple across our entire country. The WSJ reports:
California’s fiscal plight is worsening. In a letter sent Monday to the state’s legislative leaders, the governor said the Golden State now projects a new $15 billion shortfall, up from a previous estimate of $8 billion, because of plummeting tax revenue amid the recession. That figure would jump to $21 billion if Californians next week defeat the propositions, Mr. Schwarzenegger said.
Professors Ken Rogoff and Carmen Reinhart, in a dissertation, “Aftermath of Financial Crises,” highlighted declining tax revenues as one of the driving forces to increased fiscal deficits, greater government borrowing, further crowding out, and an underperforming economy. While the Governator is locked in a battle with the legislature, municipal unions, and other constituencies over the state’s fiscal follies, is California an opening act to the same show in Washington over the next few years?
Would our friends from California please share some perspectives? I thank you.
LD
