Tuesday, July 7, 2009

The newest toxic asset - California IOU's

AlphaNinja - Trying to close the $26billion budget gap, California began issuing IOU's to state vendors. It will be interesting to see the "price discovery" of these notes, as they may not be able to be hedged like other CA obligations.

As the FT reported yesterday,

"The IOUs are due on or before October 2 and pay an annual rate of 3.75 per cent. They are transferable, which means anyone can buy or sell them."

"Because the IOUs are to be repaid in just a few months, a buyer now at even 99 cents on the dollar would get an annual yield of more than 7 per cent, said Matt Fabian, managing director at Municipal Market Advisors. If California borrowed short term in the capital markets, it would probably pay a 5 per cent yield, he said."

Prepare for the market in these investments to be both illiquid and fraught with questionable "brokers."

How did CA arrive in this mess? Two examples of legislators on Crazy Pills:

A California legislator (Noreen Evans of Santa Rosa) describing the concept of government "living within its means" in terms of spending as a "meaningless" concept. Yikes.

And California assembly speaker Karen Bass describing those against tax increases as "terrorists," as reported by the LA Times. Ain't it cute when politicians refer to taxes as "revenue?"

"The Republicans were essentially threatened and terrorized against voting for revenue. Now (some) are facing recalls. They operate under a terrorist threat: ‘You vote for revenue and your career is over.’ I don’t know why we allow that kind of terrorism to exist. I guess it’s about free speech, but it’s extremely unfair." -Karen Bass

Joel Kotkin writing for Forbes shares some insightful comments on how CA doomed itself:

"Right now California's economy is moribund, and the prospects for a quick turnaround are not good. Unable to pay its bills, the state is issuing IOUs; its once strong credit rating has collapsed. The state that once boasted the seventh-largest gross domestic product in the world is looking less like a celebrated global innovator and more like a fiscal basket case along the lines of Argentina or Latvia."

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