California ups ante in seeking U.S. help on debt sales

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California is turning to Uncle Sam for financial help on two upcoming debt offerings. One deal, a bond offering scheduled for the week of April 20, already has tacit U.S. approval.

But the second deal is much more controversial: Treasurer Bill Lockyer wants the federal government to provide some kind of guarantee on up to $16 billion of short-term IOUs California expects to issue in July.

First, on next week’s bond deal: Lockyer hopes to sell between $3 billion and $4 billion of taxable (rather than tax-free) general obligation bonds to fund infrastructure projects and other voter-mandated spending. Some portion of the deal, as yet undetermined, will be issued via the federal Build America Bonds program, under which Uncle Sam picks up 35% of the annual interest expense on the bonds.

See this post from last week for more on the taxable bond offering. Lockyer’s office says he still hasn’t decided whether to give individual investors a chance to order the bonds ahead of institutional investors, as the state typically has done with tax-free bond sales.

As for the July IOU sale, Lockyer’s spokesman, Tom Dresslar, confirmed that the treasurer is ‘seeking some form of federal enhancement’ on the debt. Translation: California wants the U.S. to provide a credit backstop to ensure that investors will step up to buy the IOUs at a reasonable interest rate.

Lockyer had no trouble selling $5 billion of short-term debt (known as revenue anticipation notes) in October. But the state’s credit rating has since been lowered again because of the ongoing budget shortfalls. And Lockyer would prefer not to pay on $16 billion of IOUs what he was forced to pay in the last sale: a hefty average annualized tax-free yield of 4% (great for yield-hungry investors, terrible for taxpayers).

In the past, banks have provided a form of insurance on the state’s short-term borrowings. But ‘we’re not going to be able to get anywhere close to what we need from the banks’ this time, Dresslar said.

It would mark a major expansion of the federal rescue of the financial system for the U.S. to begin guaranteeing municipal debt. Once the government says yes to one state, how could it turn down others? And what about cities and counties?

Nonetheless, Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services committee, is writing legislation that may provide for muni debt guarantees, a Frank spokesman reiterated to Barron’s magazine last weekend.

Presumably, California would pay a fee for any federal guarantee, just as money market mutual funds pay fees for the insurance that the Treasury began providing them last fall. That could make a muni-guarantee program a profit center for the Treasury -- as long as none of the issuers end up defaulting.

-- Tom Petruno