Major Banks stop accepting California IOU's as 'cash equivalents' today ...
It would appear that major banks are having a 'reality attack' in regard to the actual risk associated with newly issued California IOU's
from
(snip)"WASHINGTON (AP) -- The recipients of billions of dollars in IOUs being issued by California soon may be able to sell them on a regulated market, following action taken Thursday by federal regulators.
Some of the nation's largest banks say that, starting Friday, they will no longer accept the IOUs. The banks want to pressure the state to end its budget impasse, but their action could leave many businesses and families with fewer options for getting their money.
Therefore, the Securities and Exchange Commission recommended Thursday that the IOUs, which carry an annual interest rate of 3.75 percent, be regulated by the Municipal Securities Rulemaking Board as a form of municipal debt. As of Wednesday, the state had issued more than 90,000 IOUs worth $354 million.
A regulated market for the IOUs would make it easier for individuals holding them to sell them at a fair price, analysts said.
The SEC oversees rules set by the nongovernment MSRB, which polices the municipal securities markets for fair pricing, disclosure and adherence to the requirement that the securities sold be suitable for the buyer.
The SEC said in an announcement that its staff "has expressed its belief that California's recently issued IOUs are 'securities' under federal securities law."
"As such, holders of these IOUs and those who may purchase them are protected by the provisions of the federal securities laws that prohibit fraud in the purchase or sale of securities," the SEC said.
In addition, it said, those acting as intermediaries between buyers and sellers of the IOUs may need to register with regulators as brokers, dealers or municipal securities dealers.
With Bank of America Corp., Wells Fargo & Co., Citigroup Inc. and some regional banks in the state having said they won't accept the IOUs for payment after Friday, attention has turned to the possibility of a secondary market to buy up the notes."(snip)
In essence, this means that California IOU's must be treated as the newly issued '3.75% municipal bonds' they actually are from a legal standpoint.
- this means that, after today, anyone wishing to cash in these IOU's must use a registered securities broker / private agent
- this means that, after today, a broker's commission will be subtracted from the proceeds of the 'muni bond sale'
- this means that the face value amount of the IOU may no longer be honored, with the ACTUAL selling price going up and down with the bond market ( where California already has billions of higher interest rate muni bonds floating around that are already selling at a discount versus face value )
In theory, this means that a poor person receiving a California IOU must now use a securities broker or other private agent ( i.e. paycheck loan company) to 'sell' their IOU. If the face value of the IOU is say $200, the market may set the actual price at $190 ... from which the broker / agent will also extract perhaps a $10 commission. End result, the state spends just as much money, the poor person actually gets 10% less money, the broker / agent earns a commission, and the ultimate buyer of the IOU takes the risk as to whether / when California will redeem these IOU's with cash.
Re: Major Banks stop accepting California IOU's as 'cash equivalents' today ...
a bit more insight from another news story ...
(snip)"The banks, including JPMorgan Chase & Co., Bank of America Corp., Wells Fargo & Co. and Citigroup Inc. and some regional banks, are trying to pressure lawmakers to end the impasse by warning that, after Friday, they won't accept IOUs issued by the state. The move would leave many businesses and families with pieces of paper and fewer options for getting their money immediately.
Government officials and consumer advocates say the banks should be more sympathetic, especially since they've been the direct beneficiaries of taxpayer dollars.
"If they hold to that stance, then there's potential for hardship being suffered by the recipients of IOUs," said Tom Dresslar, spokesman in the California Treasurer's office.
Unless recipients are able to hold IOUs until Oct. 2, the official redemption date, "they'll have to scramble" to feed their families and meet obligations, Dresslar said.
At Rhodes Consolidated Inc. in Galt, Calif., owner Fred Rhodes said that if banks stop accepting IOUs, his family's income will suffer and the company will likely have to stop paying its own vendors. The industrial supply company provides state agencies with plumbing and electrical parts.
As California legislators haggle over how to close a $26.3 billion budget deficit, the state is expected to send out $3.3 billion in IOUs this month to private contractors, state vendors, people getting tax refunds and local governments for social services.
It is the first time since 1992, and just the second time since the Great Depression, the state has sent out notes promising repayment at a later date instead of paying its bills on time. The IOUs carry an annual interest rate of 3.75 percent."(snip)
what this second story tells us is ...
- recipients of California IOU's can only receive the full face value amount of the IOU if they hold that IOU until it 'matures' in October ... assuming of course that in October California will pay cash instead of just issuing another IOU.
- it would appear that credit unions are willing to continue putting up their 'cash' in exchange for the face value of IOU's. This is likely to draw a large number of new 'customers' away from the big banks and toward credit unions. However, if California doesn't pay 'cash' for these IOU's in October, these credit unions could find themselves in deep trouble re capital reserves. This could cascade into all sorts of new problems i.e. credit unions not having sufficient 'cash' to make new auto / home loans, credit unions going into default etc.
- even if credit unions continue putting up their 'cash' in exchange for IOU's for individuals, this does NOT help any California businesses or county / local governments. As inferred in the news blurb, California businesses and county / local gov'ts will either need to 'take the loss' of a discount vs face value + broker commissions to sell their IOU's before October 2nd , or they must hold these IOU's until October 2nd (hoping that the California state gov't doesn't 'default' and replace these IOU's with 'new' IOU's instead of paying cash ) and find some other source of funding with which to pay their employees / suppliers / beneficiaries. This is likely to be highly problematic since lines of credit for businesses have been shrunk recently ( to protect banks from eating huge losses as businesses head for bankruptcy ) and interest rates which counties / cities must now pay on newly issued muni bonds are far higher than the 3.75% rate paid on the state IOU's
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Re: Major Banks stop accepting California IOU's as 'cash equivalents' today ...
That's tough for CA employees and creditors. How will CA ever settle out if that happens, not that settling out wouldn't be better than issuing more and more credit for normal budgetary expenses.
Re: Major Banks stop accepting California IOU's as 'cash equivalents' today ...
actually, since the SEC ruling on California IOU's, the proverbial water has gotten even muddier ...
(snip)"In other words, if banks or others don't like IOUs, they can trade them in the market for cash. So banks should be thrilled, right? Not exactly. AP says:
A spokesman for JPMorgan Chase & Co. left open the possibility Thursday of a change in that bank's policy, but spokesmen for Bank of America and Wells Fargo said those banks still planned to cease honoring the notes. Citigroup had no immediate comment.
It wasn't long ago that I can still remember those very same banks running to the government, hat in hand, begging for a bailout. Now when a state government comes to them, asking for some flexibility, banks don't seem eager to return the favor. Why wouldn't they accept these IOUs -- especially now that they can just be traded in the secondary market for the cash they'd prefer?
I can't speak on behalf of banks, but I can offer up a theory. As one of the article's sources explains:
The price (IOU sellers) receive may be discounted in accordance with the market's perception of the risk of the state repaying the notes, but it would be an orderly market price.
And the SEC, via AP, adds:
As with any new securities, the robustness of the trading market that will develop "cannot be predicted with certainty."
These two concerns are risks. The first is California's default risk -- the likelihood that the state will declare bankruptcy and welsh on its debt. The second is liquidity risk -- the potential difficulty IOU-holders might have in selling them in the market. Each of those risks reduces the market value of the IOUs. For example, if default risk reduces the price by 15 cents on a dollar, and liquidity risk reduces the price an additional 5 cents on the dollar, then the market value of an IOU is only 80 cents on the dollar. (To be clear, these are just fictional risk estimates. I have no intimate knowledge of IOU market pricing.)
So what's the point? If California writes a $10 million IOU to Citigroup, and the market value is only 80 cents on the dollar for that IOU, then Citigroup will only be able to get $8 million for it in the market. That's a 20% loss in this scenario. Suddenly, the banks' side seems a little more sympathetic.
Of course, California should be able to get around this problem, at least partially. They should write IOUs for amounts that cover the discount for market value of the IOUs. Using the 80 cents on a dollar example, instead of providing Citigroup with $10 million of IOUs worth $8 million, California could provide $12.5 million of IOUs worth $10 million in the market -- what Citigroup is actually owed. "(snip)
^^^ obviously the thought of the state of California being forced to pay 'de-facto' interest rates of 25%+ as a result of their 'securities' IOU's experiencing a 20% cash value loss the minute they hit the broker's trading floor only exacerbates the state's budget problems in future years.
However, there is a much more insidious aspect as well which concerns individuals and businesses who have already cashed in California IOU's ...
(snip)" If the banks accept the IOU's, and credit people's accounts with cash, and the state defaults, the banks won't be the only ones left holding the bag. If banks accept the IOU's, they'll do so with the understanding that the IOU's are recourse deposits. This means that if you deposit one, the bank credits your account, and California defaults, the bank can come after you for the full face value of the deposit. In other words, not only are California's creditors at risk of losing their money from state default, the state is making them parties to its own default liability"(snip) - from the same link.
Yes that's right ! If for whatever reason the state of California fails to pay out in cash the full face value of these 'securities' IOU's - plus 3.75% interest - by this coming October 2nd, every individual Californian and California business who cashed IOU's through major banks is potentially subject to having the bank 'confiscate' other cash out of the individual and business bank accounts to cover the difference between the IOU's face value ( with which these individual and business bank accounts were credited) and the IOU's actual market value ( which may be 20% less than face value by next October ).
The 'tin foil hat' crowd would tell you that this possibility i.e. being required by bank regulators to recover lost IOU cash value from individual and business account holders who previously cashed IOU's at full face value, is a major reason that the banks have stopped directly accepting California IOU's. And while nobody mentioned it, the California credit unions that are continuing to accept California IOU's from account holders are under identical regulatory mandates to recover 'losses' from depositors if California doesn't cover their IOU's in cash by the October 2nd maturity date.
So the big question is ... what is likely to change in California over the course of the next 3 months that is going to provide the state with the additional billions of dollars IN CASH needed to pay off these 'securities' IOU's ?
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Re: Major Banks stop accepting California IOU's as 'cash equivalents' today ...
And here I thought Schwartzenegger was a fiscal conservative.
Maybe I'll look into providing a 'swap' policy where I'll guarantee .05% below the documented purchase price of CAIOU's. Don't think of it as insurance though because I have no reserves.
Re: Major Banks stop accepting California IOU's as 'cash equivalents' today ...
I'm thinking "Last Action Hero 2" - 50% of the proceeds go towards paying off CA's debt.