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California makes pitch to White House for debt guarantee

May 13, 2009 |  5:30 am

The Obama administration may have to decide whether helping California through its current budget crisis would be like feeding a desperate addict's habit without demanding rehab.

California Treasurer Bill Lockyer made his case to White House and Treasury officials on Monday for what would be an unprecedented federal guarantee of the state’s huge upcoming sale of short-term notes.

As every Californian knows by now, we’re broke. Lockyer will be forced to borrow what could be tens of billions of dollars beginning in July to bridge the gap between the state’s current cash needs and future (they hope) tax revenue.

Normally, these short-term municipal note sales are no big deal. But because of California’s deepening budget woes and its low credit rating, Lockyer says investors are likely to demand exorbitant rates on the notes if they’re sold without a third-party guarantee.

Major banks typically provide that guarantee, but Lockyer says they aren’t willing this time. That leaves Uncle Sam as his only hope.

Lockyer How much would investors demand on the notes without a guarantee? Matt Fabian, senior analyst at research firm Municipal Market Advisors in Westport, Conn., figures California might have to pay annualized tax-free yields of about 5% to borrow for one to two years without a U.S. backstop.

With a guarantee the yields might be about 1%, Fabian said. Lockyer estimates the interest savings could be as much as $1 billion.

Tom Dresslar, Lockyer’s spokesman, says the treasurer spoke by phone with "high level" White House and Treasury officials, but Dresslar declined to name them without their approval. White House and Treasury spokesmen didn’t immediately respond to a request for comment.

Lockyer believes that the Obama administration could create a guarantee program by executive order.

Rep. Barney Frank (D-Mass.), the chairman of the House Financial Services committee, backs California’s request. Although Frank is in the process of drafting legislation that could create a long-term federal reinsurance program for municipal bonds as a way to bring down borrowing costs of all muni issuers, it isn’t clear what can get through Congress, or how quickly.

Frank told Bloomberg News on Tuesday that he was "working with the administration now . . . about Treasury’s plan to do something short-term" for California.

Lockyer insists this wouldn't be a federal handout. The state would pay a fee to the Treasury for the guarantee, known as a standby purchase agreement. And Lockyer has been fond of saying that the state would never default on its debt short of "thermonuclear war," so he pitches the idea as risk-free for Uncle Sam.

He's doing his job in trying to lower the state's borrowing costs, of course. But there must be plenty of yield-hungry investors out there who are hoping the state will have to borrow without a federal backstop.

Investors who bought California's last short-term note offering, a $5-billion deal Lockyer completed in October, have been earning spectacular returns relative to the rock-bottom rates on other short-term securities, such as U.S. Treasury bills.

The seven-month California notes that are coming due May 20, for example, pay an annualized tax-free yield of 3.75%. The eight-month notes maturing June 22 pay 4.25%.

For such short-term money, those yields would have been attractive enough if they had been taxable. But they are exempt from both federal and state income tax. No wonder the state was flooded with orders for the notes, allowing Lockyer to boost what had been planned as a $4 billion offering to $5 billion.

But investors' gain was taxpayers' pain. And seven months later, the addict is just in worse shape.

-- Tom Petruno

Photo: California Treasurer Bill Lockyer

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