A while back, I blogged about the emerging secondary
market in California IOUs. At
that time, some banks, including Bank of America and Wells Fargo, had agreed to
accept the IOUs as deposits, and ads had begun to pop up on Craigslist offering
to buy the IOUs at a discount to face value. But I noted that Wall Street seemed prepared to trade the registered warrants (as the state of
California terms them) in earnest.
Since then, there have been a number of developments.
As of this writing, California has still failed to reach a
budget agreement, and even when it does, the prognosis isn’t good: many
economists predict further deterioration in the state’s economy — and revenues
– leading to another shortfall in due course. (See here for
the Reuters news item). The credit rating agencies also have their eyes on
California. Moody's earlier this
week cut its rating on about $72 billion of the state's general obligation debt
to Baa1, and said the rating may suffer further downgrades.
Which leads us to the part of this story that first piqued
my interest: the secondary market in California IOUs. . . .
Although Citibank
yesterday announced that it would continue to accept California IOUs until
July 24 (an extension from the prior deadline of yesterday), many major banks,
including JPMorgan Chase, Bank of America, and Wells Fargo, have already
stopped accepting them. (See this California State Treasury
document for full lists of banks and credit unions that will and will not
accept the IOUs). Moreover, the
SEC has declared that the IOUs are municipal securities, meaning that they are
subject to the antifraud provisions of the securities laws, but are not
required to be registered with the Commission. The IOUs are also subject to the rules issued by the
Municipal Securities Rulemaking Board, which include a requirement that the
securities sold are suitable for the purchaser. In addition, “persons engaged in the business of buying and
selling the IOUs may need to be registered as market intermediaries, such as
brokers, dealers, or municipal securities dealers, alternative trading systems,
or national securities exchanges.” (See here and here for the
SEC releases, and see the bottom of this post for a fuller list of links to
relevant state and federal documents and websites).
On Wednesday of last week, SecondMarket, a New York firm
that trades illiquid assets — including whole loans, mortgage-backed
securities and bankruptcy claims — launched a platform for trading the California
IOUs. From The
Financial Times:
A decision last week by large banks,
such as Wells Fargo and Bank of America, to stop accepting the IOUs has paved
the way for some initial trading, although volumes are expected to be very
thin. . . .
“With several major banks no longer
redeeming Californian IOUs, and with some citizens, businesses and
municipalities needing liquidity, we felt it was important to launch this
market promptly,” said Barry Silbert, SecondMarket chief executive.
Trading is conducted at the firm's Web site, www.secondmarket.com. Because SecondMarket is a registered
broker-dealer, it was in a position to quickly step in to this potential market. Although the firm launched its platform
on Wednesday, trading is not scheduled to begin until this week, and volume
will be determined by a variety of factors, including whether California is
able to pre-pay the IOUs and how many other liquidity sources (such as banks
and credit unions) continue to accept the IOUs and for how long. The IOUs pay
an annual tax-free interest rate of 3.75 percent. Although IOU redemption is
scheduled for Oct. 2, Garin Casaleggio, a spokesman for California Controller
John Chiang, said
the state would like to pay them before that, if the new budget allows. As developments continue, I’ll try to
come back here with updates. You
do the same.
For those (like lawyers) concerned with the pesky details,
links to relevant state and federal information follows, courtesy of SecondMarket:
State of California Treasurer's Office – Redeeming
Registered Warrants What You Need to Know
http://www.treasurer.ca.gov/warrants
State of California Controller's Office
State of California Controller's Office Information on July
2009 Registered Warrants (IOUs)
http://www.sco.ca.gov/eo_news_registeredwarrants.html
State of California Controller's Office Frequently Asked
Questions about Registered Warrants (IOUs)
http://www.sco.ca.gov/5935.html
SEC Staff Statement on California IOUs
http://sec.gov/news/press/2009/2009-154.htm
SEC Investor Alert on State of California IOUs
http://sec.gov/investor/pubs/californiaiou-alert.htm
MSRB NOTICE 2009-41 (July 10, 2009) – Applicability of MSRB
Rules to California Registered Warrants
http://www.msrb.org/msrb1/whatsnew/2009-41.asp
Related Post: The Secondary Market in California IOUs