Thread: Penniless And Bankrupt...California Issues IOUs

Penniless California issues IOUs

Brisk trade in new 'financial instrument' as state issues IOUs to head off budget shortfall

Andrew Clark guardian.co.uk,
Sunday 12 July 2009 17.08 BST


California governor Arnold Schwarzenegger has proposed deep cuts to social programmes. Photograph: Steve Yeater/AP

Money woes in the most populous US state have given birth to an impromptu trading market for the newest of American financial instruments – the California IOU.

Encumbered by a $26bn (£16bn) budget shortfall and a seemingly intractable political stalemate, California's state government is issuing IOUs to businesses, health clinics, college students and taxpayers who are owed money by the state.

The green documents look like any ordinary cheque except for the words "registered warrant" stamped in the corner. They carry a 3.75% interest rate and can be cashed in October, by which time California's governor, Arnold Schwarzenegger, is hoping that he will have some money.

Entrepreneurs have been quick to leap on the phenomenon, with Craigslist and eBay cluttered with offers. A website, BuyMyIOU.com, aims to match sellers of the warrants with buyers eager to snap up the above-market interest rate.

"The market's at an early stage – we're really in the infancy of it right now," said Mark Granger, president of Pacific West Managers, a finance company offering to buy IOUs. "It's a little unusual to see the state of California resorting to paying its bills like this."

California is the world's eighth largest economy but its financial situation is grave. The once booming property market has been hit catastrophically by foreclosures and its wealthy elite have seen their income wiped out by stockmarket woes. Usually 1% of the population contribute 50% of income tax revenue, but the capital gains of these rich individuals have evaporated.

Dismal relations between Democrats and Republicans have all but frozen business in the state capital, Sacramento. A two-thirds majority is required to pass any budget, but Republicans, with just over a third of the legislature, are refusing to countenance tax rises while the Democrats are balking at spending cuts.

Schwarzenegger has proposed deep cuts to social programmes, including aid for the elderly, disabled and impoverished, plus cuts to schools, healthcare and universities. Larry Gerston, a professor of political science at San José State University, says this will accentuate an already yawning gap between the rich and poor: "The state is quickly becoming an hourglass economy. The middle class is all but evaporating – people are either moving further to the top or sinking to the bottom."

The initial victims of the standoff are California's creditors, who had received 91,000 IOUs worth $354m as of the end of Thursday. High-street banks, including Bank of America, Wells Fargo and JP Morgan Chase, agreed to cash them for a few days but announced that they would not accept them beyond the end of the week.

"There's a sentiment inside the banks that the longer they accept the warrants, the longer the budget impasse will go on," said Beth Mills, a spokeswoman for the Californian Bankers Association.

That leaves IOU holders with limited options. Certain local credit unions are still taking the notes at face value. Beyond that, holders face a choice of either waiting until October to receive their money or selling them at a discount on a rapidly developing informal market.

Many online offers for the IOUs propose dubious rates. On eBay, one buyer was willing to pay $140 in return for $170 worth of IOUs. Granger, whose firm sees the debt crisis as a potentially lucrative opportunity, said a market rate was emerging of between 80 and 95 cents on the dollar. "Because they're cumbersome and troublesome to deal with, a lot of the big investment houses are not going to deal with them," he said. "And some people will just put them in their piggy banks."

Last week, the credit agency Fitch cut its rating on California's debt by two notches from "A minus" to BBB - just two levels above "junk" status. Analysts fear that there could be weeks of IOUs to come.

Gerston says a confrontational culture of extreme left-wing and right-wing politics has contributed to the morass, as has a reluctance to wake up to problems: "Californians are known as laidback for a reason they've earned that reputation. Most people just don't believe what's in front of them. They just don't buy it."

http://www.guardian.co.uk/world/2009/ju ... issues-iou

Look at them smile in the background like they have good sense...they should be embarrased!!

I think the smiles are about getting away with it again!!!