Trading California IOUs On The Open Market

The SEC says that companies holding California IOUs can trade them like stocks or bonds by handing them over to a broker. According to the agency, “The staff of the SEC has expressed its belief that California’s recently issued IOUs are ‘securities’ under federal securities law.” That means they will be traded the same way the most municipal debt is.

California is not the only state likely to issue IOUs. Budget problems in states including Michigan and New York are bad enough that the may have to adopt a California-like plan.

The value of the decision, beyond the windfall of fees to brokers, is that vendors can find out what the paper that they get from these states is really worth. It is unlikely that a $10 IOU from California is actually worth $10. The state’s troubles are that bad, and there is some chance that California will default on the IOUs or at least devalue them to save money. News came out recently that the California is trying to get vendors to cut the costs of their goods and services by 15%. That does not bode well for the IOUs trading at their face value.

Vendors may find that selling an IOU at a 10% discount now is better than taking a 20% cut later. Large bond trading firms can take that risk and there is a very good chance that they will get burned.

Douglas A. McIntyre