John McDonald

Blogging about politics, life, and the web

Banks Back Off – California IOUs in Limbo

July 9th, 2009

In my last post, I was starting to think that the banks had a really sweet deal in this crisis.  First they get to take first cut of profits on mortgages that actually weren’t profitable, then they can take cheap loans from the government.  If they wanted to put those cheap loans into safe profit margins, they’d just have to use the federal government’s money to buy up state bonds & IOUs.  But hey, who wants a few measely percents in interest?

The big stinger is that right up until these IOUs hit the street, these banks had announced their willingness to pay face value.  Once they were printed up, distributed, and ready for deposit – the big banks decided they would stop buying them after Friday.   Companies bailing on the bailout include:  Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co.  You may recognize these guys as some of the biggest beneficiaries of recent federal bailouts in the financial sector and the ones currently sending bidders to the discount window.

So what inspired the change of heart?  Was it Fitch’s recent downgrade of California’s debt payment prospects?  Or was it the fact that they realized IOUs were already being exchanged at a discount off face value…?

The state has announced that they intend to honor interest payments and redemption of the IOUs bought on the market, so the refusal of banks to take them as deposits means they’ll be left to the market price.  Check cashing establishments and speculators are reportedly scooping up the certificates for about half of face value.  In October, they’ll be able to sell these back to the state at face value plus interest!

Once again, the government has intervened to “fix” an economic mess it created.  The result?  Anyone who lives check to check gets sold out for pennies on the dollar, and those with plenty of cash lying around have a guaranteed profit opportunity.  I’d say I’m surprised, but this seems to be the contemporary standard of political-economy.

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