More bets against cash-strapped states

Friday, June 18, 2010

How ugly are the state budget problems?
Nasty enough that traders are betting that two big U.S. states, California and Illinois, are just as apt to default on their bonds as Portugal -- and almost as likely as Iraq.
Off to the races
The price to insure against a default on Illinois general obligation bonds jumped to an all-time high Thursday. The state, which is facing a deficit that amounts to half its annual budget, has had its rating downgraded by both Moody's and Fitch.
The annual cost of insuring against a default on $10 million of Illinois bonds hit $305,000, according to CMA. That's on par with what it costs to insure against a default on the bonds issued by Portugal, which has been under pressure in the market since Greece's financial problems started in earnest in December.
In the same league is California, where the annual cost was recently $296,000, CMA said. There, Treasurer Bill Lockyer has been asking the big investment banks whether they have been betting against the state by buying credit default swaps.
The banks naturally have said no, though Goldman Sachs (GS) did concede it had at one point placed a $35 million bet against California. It said it wound down its municipal proprietary trading last year.
The going rates in the CDS market say traders believe there is an equal chance -- about 1-in-4 -- that California, Illinois, Portgual or Iraq will default on their obligations within five years.
This despite the fact that California has one of the 10 biggest economies in the world, and that its general obligation bonds have a top claim on the state's income.
No matter. Many people seem to share a feeling that something in the financial world is going to go off the rails, which helps to explain the appeal of gold, among other things. Seen in that light, the wagers against the states look like about as good a bet as any.