Are California Registered Warrants a Good Investment?

Are California Registered Warrants a Good Investment?

As we all know, California started to issue the now famous (infamous?) California registered warrants, or IOUs as the media likes to call them.  A number of these California warrants are popping up on Craigslist or EBAY by holders seeking to maintain cash flow.  Some sellers are happy to get the principal under the warrant, allowing the buyer to collect the 3.75% annualized interest rate the state is paying on the IOUs until October 2, 2009, when the state will presumably redeem the warrants.

By their terms, the warrants will mature October 2nd, and the state will redeem the warrants on maturity.  Although an October 1st date was originally suggested, the date was pushed back to October 2, 2009.  If the IOUs are redeemed early, the state will pay the interest accrued up to the redemption date, instead of the full interest that would be due October 2nd.

From July 2009 to October 2, 2009 is roughly three months.   Many California banks are offering three month CDs at a rate of 0.4% with a $10,000 investment.   The same banks are paying a staggering 0.5% with a $100,000 investment.  By those standards, the California IOUs’ 3.75% are high paying investments.

The State Treasurer announced last Monday that the state would not redeem the IOUs sold by one person to another unless the IOUs were accompanied by a notarized bill of sale, signed by the original recipient.  That is not hard to do, and would be a good idea in any event.

While several banks have agreed to accept the IOUs from their customers through July 10th, there is an uncertainty about whether the banks will accept the warrants after that date.  Moreover, they will only accept the IOUs from their customers, not non-customers.

There is a suggestion by the Municipal Securities Rulemaking Board, a national body regulating the trading of muni debt, that the IOUs should be considered securities.  While no analysis of that issue had been done and no warnings have been formally issued, if the IOUs are securities, anyone who makes a business out of trading them could be breaking federal law if the business is not registered with the Securities and Exchange Commission. So Bernie Madoff better not buy any.

However, according to John Chiang, the California state controller who issues the IOUs, the warrants are not securities.  Instead the state says they are merely a form of payment.  They are IOUs, you know, like in a poker game.

The beginning group of IOUs worth $53 million was to be mailed on July 2nd, to state residents as tax refunds.  These folks are state residents who paid their taxes in cash and received their refunds in the form of an IOU (nice).  Controller Chiang estimates the state will issue $3.2 billion worth of IOUs in July totaling $20 million of interest.  Controller Chiang has opined that such interest is exempt from federal and state income taxes.  That makes the warrants an even better investment, depending on your confidence in the state’s ability to redeem the warrants in three months.