Why BofA is playing hardball with California on IOUs

Bank of America Corp. set the tone for the banking industry's response to California's decision to issue IOUs. And if we can paraphrase the message from BofA and other major banks, it's this: "We'll help you for a week. If you can’t get your act together and nail down a budget by then, you're on your own."

BofA announced late Wednesday that it would redeem in full the state’s IOUs (formally called "registered warrants") from current BofA customers who want to cash them in. But the bank set a cut-off date of July 10.

On Thursday, other big banks including Chase, Wells Fargo and Union Bank followed BofA’s lead, saying they too will cash the IOUs from customers through July 10.

Some banks, including City National, didn’t include a cut-off date, although they didn’t preclude setting a deadline at some point. Many credit unions also have agreed to accept the IOUs from customers without setting a time limit, according to Matthew Buck, a spokesman for the California Credit Union League.

The hardball strategy of BofA, Chase, Wells and other big banks will create hardships for their customers if no budget deal is struck soon and the state continues to issue IOUs instead of checks. The state set a redemption date of Oct. 2 for the IOUs, although it said it might redeem them before then if it has the cash. Other lenders may step up to buy the IOUs in the interim, but probably at a discount to face value, unlike the big banks' redemption programs.

I asked BofA why it set such a small window for customers to cash IOUs. Here’s the bank's response:

"We established a firm timeline for a few reasons. First, registered warrants present a challenging operational and financial undertaking and not something we want to manage indefinitely. So based on the state’s current disbursement estimates, we believe we can accept the items through July 10 to both help meet the immediate short-term needs of our customers and clients, while providing more time for the state to achieve a budget solution.

"Second, this time limit is also based on our experience the last time the state issued registered warrants in 1992, where the longer the registered warrants were accepted, the longer it took the Legislature to resolve the matter. So, we don’t want our acceptance of registered warrants to deter the state from reaching a budget agreement as soon as possible."

I also asked whether BofA might extend the July 10 deadline. The bank’s answer was unequivocal: "This is a firm date for us; we do not plan to ‘reconsider’ extending the acceptance date."

Note that banks will earn something for their troubles: The state will pay an annualized 3.75% tax-free rate of interest on the IOUs until it redeems them.

If recipients of the IOUs don’t need the cash right away (though that's hard to imagine in this economy), they can simply hold on to the scrip until the state finally pays up. They’d collect whatever interest has accrued up to that point.

At 3.75% tax-free, the rate of interest is far better than what you'd earn on short-term savings in a money market mutual fund . . . or at a bank.

-- Tom Petruno

Photo credit: Ricardo DeAratanha / Los Angeles Times

Comments

[haroldh]

b of a was bailed out by the feds maybe they think they're too good to give back to the people and maybe I'll switch my account from there.

[Michael Kennedy]

haroldh, I doubt they'll miss it.

[Bruce Oksol]

Many folks who will be paid in IOUs don't pay federal or state income tax (their income is too low) so the statement that the 3.75% rate is tax-free is moot for some folks.

Also, I can imagine that the cost of managing these IOUs far exceeds the $3.75% interest being paid....assuming, of course, the state is eventually good for the IOU. There's no reason why the state cannot renege on those IOUs, leaving the banks to hold worthless IOUs.

Lots going on here. I assume B of A would be more than happy to see some folks close their accounts if they (these customers) can't understand business any better than this.

[Chuck Paugh]

Federal law bans states from issuing their own currency. These so-called IOU's are state issued currency. Given the tightened regulations on banks right now, it would not be prudent for many financial institutions to accept this illegal quasi-currency. The State of California is violating federal law and the US Constitutional restriction that only the US Treasury may issue legal tender.

[JohnB]

This is just a money maker for the banks. They know the people are stuck and need the money. They just want to line their own pockets with extra fees from those who can least afford it.

[Tom Petruno]

@John B: It doesn't appear that the big banks are charging fees to redeem the IOUs. If anyone hears of a bank charging a fee to take an IOU from one of its own customers, I'd like to know about it.

Tom Petruno

[Ivan]

Why doesn't California make it illegal for the banks to skin their customers alive, and then fine Bank of America huge amounts whenever BoA slips up, just like BoA does to its customers. And if BoA threatens to pull out of California, that can only be a plus for Californians.

[bruce]

i call your attention to article 1, section 10 of the constitution of the united states of america:

"no state shall...emit bills of credit..."

these iou's are bills of credit. they are unconstitutional. take it to federal court. if there is no prompt relief from the federal courts, then there is no longer a constitution in force, in which case, each one of us is a sui juris law unto ourselves. that could lead to a really ugly situation. i am not at risk from holding california iou's (i live in oregon now, and am not a creditor of california), but if i were, and there was no longer a constitution in force to secure my rights, i could be a really ugly character.

[Gorefan]

Bruce, the Supreme Court decided in Craig v. Missouri that bills of credit are in fact paper money. That was what the term meant back when the constitution was written. Because the IOU's earn interest their value changes from day to day and are therefore not considered currency.

[SanFranciscoJim]

This is what happens when you let your state's major bank move to North Carolina. I will personally never do business with BofA again and will sell my stock in them.

[dee]

Ten days seems reasonable to me. Most people have direct deposit anyway but if I were these people I would be looking for a job because they may not have any money next month to pay their bills.

[David Justin Lynch]

Here's where the Federal government can help, by passing a law forcing banks to accept the IOUs. That's no Federal money out of pocket--and the banks really don't lose because they'd be making interest on them.

[Ann]

It makes good sense for BOA, Citi etc - the very weak banks - to refuse to accept California's IOUs. California is busted - thanks to all those voter initatives with mandatory spending programs but no source of funding and the refusal to raise taxes - and is a really really really bad credit risk!

The holders of those IOUs are unsecured creditors and thus at the back of the line on collecting. Those banks can not effectively lend money to CA by accepting the unsecured IOUs. The regulators will have a fit and the banks will be in more financial trouble than they already are.

It is pretty clear that the voters - who created this mess with Proposition 13, term limits, unfunded ballot initiatives - are not willing to help themselves by increasing their taxes.

If I has an account at BOA, Citi etc and they took unsecured IOUs from California, I would close the account. (And no I don't have accounts there because I consider those banks to be unsound.)

Calfornians brought this on themselves by demanding this that and simply everything such as the highest per capita incarceration rate in the world, mandating a percentage of the budget go to after school extra-curricular activities (WOW! Now there is a high priority item in the scheme of things! LOL!), and the list continues.

And NO Californians do NOT pay the most in state and local taxes among all the other 50 states. They are around 18th or 20th on the list. They just demand services - skate parks, firefighters to protect the homes of the fools who built in fire zones etc - as if they were paying the most taxes to pay for such things.

[pugtv]

If I was a B of A common stock shareholder, I'd be ticked off at management for accepting those IOUs. If California wants a loan, go get it in the market place at prevailing market rates. Aside from the administrative costs, why should B of A (common stockholders) be forced to give California a cheap IOU loan?

B of A common stock equity Investors are trying to maximize returns, not support California's self entitled overspending population.

[Robert Nowicki]

So, the IOU's are supposed to be paid off on October 2nd, with interest. What happens if there is no budget agreement my then? Those IOU's will be "rolled over" into new IOU's that will be due later on down the road.

And don't tell me that the state "has to have a budget agreement in place by October 2nd". They "had" to do a lot of things, like agreeing to a budget by the start of the fiscal year, which they didn't. And every day that goes by with the state issuing IOU's it will be digging that much deeper a hole to crawl out of. The death spiral has no end...

Robert

[nunya]

Why is this in a blog instead of a news article? The Times should identify blogged 'news' in the headline or otherwsie tag them so people can differentiate between them and real stories. Many of these blogged reports are politically biased and often wrong or incomplete.

[Squanto McGEe]

I left the state 20 years ago when it became obvious that the liberal mentality of taxing the crap out of the workers in order to pay for every asinine program imaginable was eventually going to bankrupt the state. California has too many deadbeats, too many government programs, and too many people with a gimmie gimmie gimmie mentality. The liberal politicians are as detrimental to the state as the Taliban are to the middle east. (Example: far left douche bag idiot politicians in San Francisco who have stated that Internet access is a basic human right). Sorry California...you elected them...you deserve what you are getting. Burn baby burn.

[meh130]

Gorefan,

The certificates Missouri issued, which were declared unconstitutional by Craig v. Missouri, were indeed interest bearing certificates. So in SCOTUS precedence, interest bearing certificates have been found to violate Article I, Section 10.

In Craig, Chief Justice John Marshall, wrote: "the term “bill of credit” may comprehend any instrument by which a state engages to pay money at a future day".