Illinois pursuing disclosures on state debt

By Dow Jones Newswires
Posted Dec. 30, 2010 at 4:35 p.m.

Illinois politicians are reviewing whether to follow in California’s footsteps by forcing its bond underwriters to disclose what credit derivatives they have entered into on the state’s debt.

Staff members working for Illinois House of Representatives Speaker Michael Madigan reached out to California officials on Wednesday for information about how the Golden State has gone about improving disclosures relating to credit default swaps on its own state debt.

Hedge funds are increasingly using municipal credit default swaps to speculate on the likelihood of state defaults rather than as legitimate risk mitigation tools. Illinois politicians’ interest in the derivative instruments comes as Governor Pat Quinn considers ways to address the state’s growing mountain of debt.

Steve Brown, a spokesman for Madigan, said CDS on municipal debt was an area that caught the speaker’s attention very recently. It is still unclear if the Illinois general assembly will consider adopting a stance similar to California’s, however.

“No decisions have been made about whether this ought to be a policy of Illinois, but another state has developed such a policy … and when people are attempting to bring reform, it’s an attractive area to look at,” Brown said.

Kelly Kraft, a spokeswoman for Gov. Quinn, said John Sinsheimer, director of capital markets for Illinois, has not asked any of the state’s banks to detail their CDS trading, and is not involved in the speaker’s research project. She added that Sinsheimer would have to be involved if any such project were to be formally undertaken, since he runs the state’s debt sales.

As of Dec. 28, CDS on Illinois were quoted at 347 basis points, which means it would cost $347,000 annually to insure $10 million of state debt over 10 years, according to CDS pricing service Markit. The cost to insure the same amount of California bonds was $303,000 annually.

The last time default insurance on Illinois debt was that expensive was June 30, when coverage reached a record of $365,000 a year.

Earlier this month, California’s state Treasurer Bill Lockyer began requiring all 86 of the state’s underwriting banks to submit quarterly reports detailing what CDS they had entered into on California state bonds.

They must supply information on the notional volume they have traded with customers — and whether they took a bullish or bearish position on the trade — by Jan. 31 based on CDS written through Dec. 31 of this year.

While California’s treasurer does not have the authority to prohibit banks from trading CDS on state bonds, “It can take their CDS activities into account when making decisions about membership in 1 8 its 3 8 underwriting pool, and in selecting bookrunners for 1 8 its 3 8 bond sales,” said Tom Dresslar, a spokesman for Lockyer, in an email Dec. 16.

Illinois could do the same. The gross value of CDS written on Illinois grew 0.65 percent in the last month, according to data from the Depository Trust & Clearing Corp., but the net value of CDS on Illinois, which reflects the actual exposure of traders once buy and sell contracts have been offset, declined 4.58 percent. A year ago, Illinois debt did not feature in the top 1,000 reference credits in CDS trading.

-By Katy Burne, Dow Jones Newswires

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  1. Amy Dec. 30, 2010 at 10:38 pm

    Wow. This sounds like someone in Illinois (Madigan???really???) is actually looking at this from a sound financial perspective–there’s something wrong with this picture.

  2. jack (me) Jan. 1 at 9:48 a.m.

    Amy: “–there’s something wrong with this picture.”

    In essence, what’s wrong is that anyone buying Illinois bonds is taking a big risk. Apparently the bond insurers aren’t able to offset it, so the purchasers are using derivatives.

    Basically, though, buying an Illinois bond is like buying a mortgage on a house with a fraudulent appraisal. You see how that turned out in 2008.

    If Madigan were looking at it from a sound financial perspective, he would be trying to find a way to balance the budget. Since the state does not have jurisdiction over the secondary market, this is just more smoke and mirrors.