On March 29, Bill Lockyer, Treasurer of the State of California, sent an identical letter to each of six banks requesting disclosure concerning each bank’s “market activities related to credit default swaps on municipal bonds in general, and State of California general obligation (GO) bonds specifically.”
The banks are (click the link to upload the letter):
The request on its face is very broad, but in fact is limited by a short questionnaire attached to each letter. Still, each bank will have to grapple with how to frame the response, especially to the question asking the banks to “describe, in your view, how State of California CDS trading, in recent years, has affected the State, its bond sales and the borrowing costs paid by taxpayers.” Could it be possible that the banks offer up inconsistent and contradictory answers?
Lockyer notes that these payments on CA debt are second highest in priority right behind paying for schools. This priority, Lockyer argues, means that GO bondholders have a cushion of 8-1 on their investment in GO bonds. The 8:1 ratio is calculated based upon the Governor’s revised 2009110 budget projection of General Fund revenues at $88.1 billion, school spending at $41.8 billion, and GO debt service for FY 2009110 is projected at $5.2 billion.
Thus, the treasury’s hunt for information is aimed at answering one head scratching question: Why is California’s debt viewed in the CDS market as riskier than Kazakhstan given that the market should be aware that there is a debt coverage ratio of 8:1, repayments ranks in priority second only to payments to schools, and that the money is continuously appropriated, meaning that debt service gets paid even if the California has no budget?
As a California taxpayer, I say “good question.” The answer, if submitted timely per the letter’s request, is due on April 12, 2010.
Mr. Lockyer acknowledges that he does “worry” about whether and to what extent these banks participate in the municipal CDS market while they act as underwriters of and sell California GO bonds. As a lawyer, I say, “banks beware.” Even though Mr. Lockyer said he has no preconceived notions, this hunt for information could lead to potential adverse claims such as market manipulation or other securities violations.
If you have questions or would like to discuss this further, contact Jeffrey Wittenberg at (877) 352-2010.