California IOUs speculation heats up as banks stop redeeming state warrants

July 8, 2009 | By Julie Small | KPCC
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Julie Small/KPCC

California issues IOUs

Californians who’ve received IOUs from the state instead of cash payments will find it harder to redeem those documents after tomorrow. That’s when 10 financial institutions, including Bank of America and Wells Fargo, plant to stop redeeming the IOUs. KPCC’s state capitol correspondent Julie Small reports that the lure of high interest has created an alternative market for the stuff.

[Sound of IOUs printing]

Julie Small: Late last week, printers in Sacramento churned out IOUs to pay the state’s bills. California mailed them because the state legislature couldn’t agree on a budget. If there’s still no budget by the end of this month, the state will issue more than $3 billion worth of IOUs and billions more each month state lawmakers delay the budget.

But 10 major banks have said the IOUs won’t be any good after tomorrow. That means people on the receiving end may have to rely on people like Jeremy Smith.

Jeremy Smith: At SecondMarket.com, what you’ll see is essentially a pop-up that says we’ve now opened our marketplace for the California IOUs. Click here if you are interested in buying. Click here if you’re interested in selling.

Small: Smith’s New York-based company Second Market trades illiquid assets. He’s waiting until next week, after the big banks stop accepting California’s IOUs, to open trading. That’s when he expects plenty of people will want to sell them on his site.

Smith: Local governments – that’s going to be a meaningful group of sellers, also vendors of the state of the California and individuals expecting to have tax returns sent to them.

Small: Smith says he’s confident that sellers will get close to the face value of their IOUs. That’s because if a buyer purchases the IOU for even a penny less than the face value a month before the redemption date, that’s a 1 percent return.

Smith: If you annualize that it’s a 12 percent return. Plus the interest payment they receive when the state redeems it.

Small: That 3.75 percent interest isn’t subject to federal taxes. California has promised to pay the money and interest by October. Second Market will split a fee of 1 to 5 percent between buyers and sellers.

But the company has said it will sell IOUs worth less than $5,000 at no charge. Smith’s business is a registered broker dealer regulated by the federal Securities and Exchange Commission. Individual investors are also gearing up to trade California’s IOUs.

Brandon Schlichter: On the front of the Web site there should be a sign-up sheet.

Small: Brandon Schlichter is an online advertising entrepreneur and real estate broker in Ohio. Now he’s an IOU matchmaker. Last week he launched his website BuyMyIOU.com and started advertising on Craigslist.

Schlichter says that so far, buyers outnumber sellers – and they’re offering about half the IOUs’ face value. Many have just enough cash to buy more than $1,000 worth, although one says he wants to unload $100,000 dollars of IOUs. Schlichter’s still figuring out how to securely handle money and verify that IOU sellers are legitimate.

Schlichter: As far as assurances go, I really don’t have any, and that’s the unfortunate part of this.

Small: But you still have people putting their stuff for sale on your site?

Schlichter: Yes, they’re sending me request forms and I’m contacting them.

Small: The potential for the unregulated trade of California’s IOUs has prompted the state treasurer to require notarized bills of sale from people who buy IOUs from one another. That won’t stop the trading, but it could curb fraud. Treasurer’s spokesman Tom Dresslar said the state agency didn’t want to close options for Californians who may be desperate for cash.

Tom Dresslar: They’re going to be left scrambling to turn their IOUs into cash they need to support their families. So we don’t want to on the one hand shut off alternative avenues to making that happen. On the other hand we have a duty to protect taxpayers from getting ripped off.

Small: The state treasurer has criticized banks for not accepting the IOUs after this week. Beth Mills with the California Bankers Association says banking officials have their reasons.

Beth Mills: For some of the banks there’s a willingness to provide a short-term solution for their customers and for the state, but ideally what they’d like to see happen is for the state to reach a budget solution as quickly as possible so that the controller will no longer need to issue the IOUs.

Small: Mills says that just because banks won’t redeem the IOUs doesn’t mean they won’t help customers with lines of credit or other ways to weather the state’s fiscal crisis. She urges IOU holders to contact their banks before they try to sell to the highest bidder on Craigslist and eBay.

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