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California IOUs to be shunned by big banks after today

Bank of America and other big institutions plan to enforce a cutoff, making it harder to cash vouchers. To protect IOU holders from third-party speculators, the SEC defines the vouchers as securities.

July 10, 2009|Tiffany Hsu

People holding California state IOUs -- including taxpayers, vendors and local governments -- will soon have a tougher time redeeming them, as most major banks are standing firm on a vow not to cash the vouchers after today.

Many credit unions say they will continue to redeem the IOUs for customers. But without mainstream banks as an option, recipients of the IOUs who need cash immediately could be tempted to sell them at a discount to third-party speculators, including ones popping up on the Internet.

Responding to that potential, the Securities and Exchange Commission determined Thursday that the IOUs are securities under federal law, which will generally require anyone trading them for profit to be a registered securities dealer.

The move is aimed at limiting the risk that IOU recipients could be defrauded by individuals or companies that offer to buy the scrip.

"The SEC's action has the potential to, at least a bit, reduce the shark factor and potential for taxpayers to get defrauded," said Tom Dresslar, spokesman for State Treasurer Bill Lockyer.

As lawmakers continue to butt heads over a $26-billion budget deficit, the state's payment system is expected to crank out nearly $3 billion this month in interest-bearing IOUs, also known as registered warrants.

In the last week, State Controller John Chiang's office issued 91,000 IOUs worth $354 million to people expecting tax refunds, as well as to state vendors and local governments, said spokeswoman Hallye Jordan.

The state will pay an annual tax-free interest rate of 3.75% on the IOUs, which creditors can redeem Oct. 2 when they are scheduled to mature. But if they need the funds immediately, they now may need to turn to credit unions and check-cashing companies.

Most major banks reiterated that customers could not deposit the IOUs after today. Others, such as City National Corp., said they would continue accepting the registered warrants but could stop taking them at any time.

The last time the state sent out IOUs, during a 1992 impasse between then-Gov. Pete Wilson and legislators, banks also eventually rejected the registered warrants.

"We agreed to help customers and clients on an immediate basis, but it doesn't provide an incentive for the state to reach an agreement if we just accept the IOUs through perpetuity," said Bank of America Corp. spokeswoman Britney Sheehan.

Last week, Bank of America said it would do the state a favor by redeeming IOUs from current customers at full value -- but only until today. Other major banks quickly and begrudgingly followed suit.

Wells Fargo & Co. was "pretty reluctant to accept the warrants in the first place," said spokeswoman Mary Trigg.

The bank also will reject the IOUs starting Saturday, but it will work with customers on a case-by-case basis to manage short-term financial needs, she said.

"We feel the state of California has to be responsible for living within its means," Trigg said. "The banks aren't the solution to the state's budget problems. We're trying to strike a balance between how grave the situation is and the needs of our customers."

Bank of America will try to use existing services and strategies, such as waiving account maintenance fees or clearing overdraft fees, to help customers who depend on state checks, Sheehan said.

Other banks may offer temporary lines of credit or short-term loans, said Beth Mills, a spokeswoman for the California Bankers Assn. Several smaller banks are planning to continue accepting the warrants; others may accept IOUs for some customers but not others.

Still, some say the banks are stranding their customers in desperate times. Lockyer's office intends to call banks that have set a cutoff for today and urge them to continue cashing the scrip.

"We would urge financial institutions to do right by their customers," Chiang spokeswoman Jordan said. "Private businesses and citizens are receiving these IOUs through no fault of their own, so why penalize them further?"

At least 60 California credit unions have agreed to accept IOUs, according to the California Credit Union League trade group. Most will not set a deadline to deposit the IOUs, and all will redeem the registered warrants at face value, said league spokesman Henry Kertman.

Though some of the member-owned credit unions may decide to redeem IOUs only for current account holders, many others hope to grab some market share from banks no longer honoring the IOUs, Kertman said.

"Some are looking at the situation as an opportunity to differentiate themselves and open their doors to more consumers," he said.

One advantage for many credit unions, which mostly avoided the risky loans that burdened banks, is that they can afford to sit on the IOUs until the state pays them off.

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