Lockyer Asks Banks About Role in CDS

ALAMEDA, Calif. — California Treasurer Bill Lockyer has sent another round of questions to six large investment banks about their involvement in credit default swaps linked to California bonds.

The questions, sent in letters Wednesday, follow an earlier round of questions Lockyer posed to the banks in late March, the answers to which the treasurer’s office posted in April.

According to the office, the new round of questions is designed to elicit more information about the extent to which the banks themselves use CDS to bet against California’s credit, the extent to which they help their clients use CDS to bet against the state’s credit, and the extent to which they facilitate speculative trading of California CDS, defined as trading by parties who have no actual exposure to the state’s bonds.

The six investment banks — Bank of America Merrill Lynch, Barclays, Citi, Goldman Sachs, JPMorgan, and Morgan Stanley — have received a combined $215 million in underwriting fees and commissions from California since 2007, the treasurer’s office says.

“The same banks are playing around in the market for buying and selling credit default swaps linked to those same bonds,” said Lockyer spokesman Tom Dresslar. “So the treasurer is trying to make some firm determinations of the extent to which the banks marketing our bonds on one hand are engaging on the other hand with trades that could harm taxpayers.”

In an April 22 news release summarizing the six banks’ responses to the first round of questions, Lockyer said that the data suggest the firms themselves did not bet against the credit quality of California general obligation bonds.

He also said he would seek more information to further clarify the extent of their proprietary trading.

“A question we are asking the banks is, why is it appropriate for you, given the fact taxpayers hired you to market their bonds, why is it appropriate for you in any way to bet against California’s credit on your own account, or to facilitate bets against California by their clients?” Dresslar said.

The banks have until May 26 to respond.

“Your answers will help us determine the best way for our office to deal with the municipal CDS market and its participants going forward,” according to the letters, all posted on the treasurer’s website.

There are nine questions in all, most with further sub-questions.

In addition to more detail on the amounts and types of CDS trades the banks facilitated, they are asked how much money they’ve made on such trades, and what their future plans are for California CDS trading.

The final question asks the firms if they believe California taxpayers benefit from speculative trading on California bond CDS.

“If your answer is yes, please tell us how any perceived benefit could outweigh the potential financial harm speculative trading could inflict on taxpayers,” the question concludes.

Lockyer in April said his office will begin to require all the firms in the state’s underwriting pool — currently 86 — to provide quarterly reports with detailed information on their CDS market activity.

Late last week, Lockyer, in a letter to Senate Banking Committee chairman Christopher Dodd, D-Connecticut, asked that pending financial regulatory reform regulation limit the use of municipal credit default swaps to those with actual exposure to the credit.

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