Banks Turn the Screws on California

(page 2 of 2)

Feldman says he made good money earlier in the year buying the bonds of distressed companies such as General Growth Properties and Hertz (HTZ). California, he says, is just another distressed issuer. "They've had their ratings lowered but they're not junk status, yet," he says.

The Securities and Exchange Commission has declared that the IOUs are municipal securities, meaning that only dealers authorized to trade in such paper can do so. In a statement, the agency also warned that "broker-dealers, as well as any potential secondary markets, should be aware that the requirements of the securities laws and the rules of the Municipal Securities Rulemaking Board apply to the IOUs." Other security steps may be taken. The controller's office is expected to require a bill of sale for all who try to redeem an IOU that was not issued in their name. "It's going to be more painful for people who are trying to sell them for money," says Matt Fabian of Municipal Market Advisors, a research firm devoted to municipal bonds. "There are additional hoops to jump through to sell municipal securities. It would really be unfortunate for the people of California, and increase pressure on the state to get something done."

This is only the second time that California has had to issue IOUs since the Great Depression. The last time, in 1992, a budget compromise was reached, in part because banks refused to cash the paper.

Market on eBay

IOU recipients may not all be on the hook, however. One IOU being offered for sale on eBay (EBAY) already appears to have appreciated in value. Bidding on the $2 check—issued to cover a state tax refund—has already risen to $21. The auction ends July 16. "Hopefully this will never happen again," the eBay listing says. "This is a piece of history right here."

Palmeri is a senior correspondent in BusinessWeek's Los Angeles bureau. Craig is a reporter for BusinessWeek in Washington, D.C.

Business Exchange

Track and share business topics across the Web.