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Burgeoning California IOU market faces hurdle
By Laura Mandaro, MarketWatch
Last Update: 7:02 PM ET Jul 8, 2009
SAN FRANCISCO (MarketWatch) -- A nascent market that's grown out of cash-strapped California's move to issue paper promises to its vendors may have hit a snag, relegating trades in these newly printed IOUs to privately negotiated transactions.
Investors have shown interest in buying some of the $3 billion in IOUs the state started to issue last week to businesses and taxpayers it owes money, as long as they could buy them at a discount. They are, after all, a form of small-denomination municipal debt.
But without a solid way of identifying these certificates, or a clearing house like Euroclear to settle trades, the deal's off, says one trader.
"My view is that California is not going to default, that these things will be paid off," said Andrew Brenner, a trader with MF Global. He said he looked into buying IOUs for clients that saw an opportunity to buy the notes, known as "state-registered warrants," at a discount and then redeem them at full value when the state sorts out its cash problems.
But without a CUSIP, or standard way of tracking individual securities, "there's no way to identify it, no way to clear it," he said. "I'm not going to eBay." EBAY
On July 2, the state started issuing IOUs after Gov. Arnold Schwarzenegger, the state legislature and voters failed to agree on a deal to bridge the state's roughly $24 billion budget deficit.
The state will pay a 3.75% annual interest rate when it redeems the IOUs, and it's vowing to do that no later than Oct. 2.
Major banks such as J.P. Morgan Chase & Co. JPM, Wells Fargo & Co. WFC and Bank of America Corp. BAC have said they will accept the warrants from customers until Friday.
Shortly after state Treasurer Bill Lockyer announced plans to issue the IOUs, ads started to pop on Web sites such as Craigslist.org from people looking to buy the IOUs, preferably at less than face value. One lure is the belief that lawmakers will eventually figure out how to close the budget hole, either by raising taxes or cutting services, or both. Some are just looking for souvenirs.
"Got an IOU and need cash now? I am paying 85 cents on the dollar for any / all California IOU's," read a posting Tuesday on Craigslist.org by a user in Sunnyvale, Calif.
Demand to buy these IOUs for prompted Lockyer's office earlier this week to release ground rules for redeeming IOUs sold to third parties. The state Treasurer's office said it needs to see a notarized bill of sale signed by the payee whose name appears on the warrant.
On Monday, Fitch Ratings downgraded the state's bond ratings to BBB from A-, citing the state's "continued inability to achieve timely agreement on budgetary and cash flow solutions to its severe fiscal crisis."
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