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California asks Wall Street banks for details on trading in 'default swaps' on state bonds

March 29, 2010 |  4:05 pm

California Treasurer Bill Lockyer wants to know whether big banks that help sell the state’s bonds could be driving up interest rates on those securities via trading of so-called credit default swaps.

Lockyer late Monday sent letters to six of the biggest Wall Street banks asking for details on their activities with credit default swaps, contracts that are a way to buy insurance against debt default.

California’s severe budget woes naturally have raised questions about the state’s long-term fiscal health, and that has been reflected in higher costs to insure California general obligation bonds against default via the swaps market.

At least, that’s how Wall Street tells it. But Lockyer worries that there could be something else going on. If speculators are pushing up the cost of swap contracts -- hoping to stoke fears about California’s ability to make debt payments -- that could force the state to pay higher yields to issue new bonds to nervous investors.

Lockyer The treasurer isn’t alleging that that’s what is happening, but he wants the banks to tell him whether that’s a possibility -- and whether the banks, all of which have managed debt offerings for the state, also could be hurting the state by trading in the swaps market.

California just last week wrapped up a bond sale that raised $3.4 billion to fund infrastructure projects. The deal was handled by Citigroup and Bank of America. They received Lockyer’s letter on Monday, as did Barclays Capital, Goldman Sachs, JPMorgan Chase and Morgan Stanley. None of the banks had any immediate comment.

“I have no preconceived notions about the effect of credit default swap trading on California general obligation bond prices, or about your firm’s activities in the credit default swap market,” Lockyer said in the letter. “I do, however, worry about firms selling our bonds, on the one hand, and trading credit default swaps on our bonds, or otherwise participating in that market, on the other.” . . .

The swaps markets also has been under intense scrutiny in Europe amid Greece's fiscal turmoil. Some European leaders have suggested banning certain swaps trading.

Lockyer's letter asks the banks to provide “detailed information” on their roles as market-makers and traders of California credit default swaps, and their views on “how California credit default swap trading, in recent years, has affected the state, its bond sales and the borrowing costs paid by taxpayers.”

The treasurer noted that in recent months the cost to insure California  bonds against default via the swaps market was higher than the cost to insure bonds of some Third World countries, including Kazakhstan, Bulgaria and Thailand.

Lockyer believes that’s ridiculous, saying in the letter that “the state’s general obligation bonds are backed by the full faith and credit, and taxing power, of the eighth-largest economy on the planet.” He also noted, as he has many times over the last year, that payments to bond investors are mandated by the state Constitution.

-- Tom Petruno

Photo: California Treasurer Bill Lockyer

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