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Why BofA is playing hardball with California on IOUs

July 2, 2009 |  6:21 pm

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.

Bofasign 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

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