Remember when the US government had to bail out investment banks? Now a bank is bailing out the state of California.
California had been covering its budget shortfalls by issuing IOUs to pay for services, making it the first state to issue its own fiat currency since the Civil War. The program ran into trouble when banks announced they wouldn’t keep cashing the IOUs.
Eventually California reached a budget deal and kicked the can down the road, but there’s still the issue of the outstanding IOUs.
Yesterday JP Morgan agreed to lend California $1.5 billion to fund the program to redeem the IOUs. State controller John Chiang has announced the redemptions will begin on September 4th.
A plausible case can be made that this is an indirect bailout by the US government of California. JP Morgan is deemed to big to fail, and can borrow from both the Fed and at reduced costs in the market because of its status. This makes it far easier for the bank to lend confidently to California. What’s more, JP Morgan can assume that if California were to come close to defaulting on the loan, the US government would bail out California.
Just what JPMorgan will earn on the loan hasn’t been determined, Dresslar said. The terms are still being worked out, he said. Lockyer will have to be able to make the case that the private placement of the debt with JPMorgan is as good as or better than any deal the state could get with other banks.
The risk to JPMorgan is virtually nil: The loan will be repaid by late September, when the state plans to sell $10.5 billion of so-called revenue anticipation notes, or RANs — securities that will mature next spring. Individual investors are expected to flock to the RAN offering as a place to stash cash, because the notes should offer much more lucrative returns than money market funds and other short-term accounts paying next to nothing.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.