No evidence Wall Street drove up California’s borrowing cost, Lockyer says
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There is still no evidence that Wall Street improperly drove up borrowing costs for the state of California, Treasurer Bill Lockyer said Friday as he released a second round of findings from a probe of so-called credit default swaps.
The swaps, contracts similar to insurance, are designed to cover investors’ losses if a bond issuer misses payments. When California’s fiscal problems flared this spring, the market yields on the state’s existing general obligation bonds surged. At the same time, the price of credit default swaps written against the state’s bonds climbed, benefiting holders of that insurance-like protection.
As a general rule, higher yields on the state’s bonds suggest it will have to pay more in interest the next time it borrows.
Lockyer wanted to know whether the yields rose because speculators in the swaps market were fomenting unwarranted worries about the state. He also wanted to know whether the six giant Wall Street banks that underwrite California’s bonds had themselves bet against those same bonds.
The treasurer sent two rounds of questions to the banks -- Bank of America Merrill Lynch, Barclays, Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley.
The firms’ responses to Lockyer’s follow-up questions confirmed his preliminary findings, he said Friday.
“One,” Lockyer said in a news release, “the effect of CDS trading on California bond prices is not significant enough to cause concern at this time.”
“And two,” he went on, “the banks themselves have not bet against the credit quality of California GO bonds to any meaningful extent.”
There was still uncertainty, Lockyer said, about how often the banks facilitate their clients’ “naked” trading of California credit default swaps – transactions made solely to bet against the state’s bonds and not as a hedge by investors who actually own the securities.
The Wall Street firms said they didn’t know what motivated their clients to buy California credit default swaps. “The banks said clients do not disclose why they want to buy CDS, do not want to provide such disclosure, and that such confidentiality helps the market function efficiently,” Lockyer said.
Lockyer said he backed a measure under consideration in Congress that could discourage speculative trading of swaps by requiring buyers and sellers of the contracts to put up more collateral and use less borrowed money.
-- E. Scott Reckard
