Investors offer cash on Craigslist for Calif. IOUs

SAN FRANCISCO - Online cash offers for California IOUs are proliferating on Craigslist and elsewhere as major banks stop accepting the financially strained state's promises to pay.

Eager buyers are offering anywhere from 60 to 95 cents on the dollar in hopes of scoring quick profits come October, when the state says it will pay the promissory notes' face value plus interest.

"Don't wait until fall to get your money!" says one Craigslist ad. "We offer immediate payment for your California IOUs instead of playing the waiting game with the state government," says another.

Small businesses that contract with California are tempted, saying they need the cash in hand to keep operating, but they also cannot afford the losses that would accompany selling their notes at a discount.

As of July 15, the state controller's office had issued 137,000 promissory notes worth $640 million. The treasurer's office has promised to redeem them, plus pay interest at a 3.75 percent annual rate, by Oct. 2.

Contractors and residents owed tax refunds are getting promissory notes instead of checks from the state because lawmakers have not been able to close a $26.3 billion deficit. Negotiations over spending cuts stalled late this week, and the timing of an agreement is anyone's guess.

The rise of the secondary market for IOUs appears spurred by the decision of JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. to stop accepting the IOUs a week ago. As a result, many small businesses are facing a cash flow crunch as they struggle to honor their state contracts without getting paid.

"We're going to try to ship what we can, but it places a real burden on small businesses," said Gerry Ross, vice president of Newport Beach-based Pueblo Trading Co., which supplies turkey, chicken and deli meat to state prisons and hospitals.

Ross said if his banks do not take his California IOUs, he may have to sell them to keep cash flowing and food moving.

"I have to do what I have to do," he said. "We've been in this business for 25 years, and I'm not about to sacrifice the relationships with the people we do business with."

At the same time, he said, the low margins in the food business mean his company probably can't afford to offer the IOUs at a discount. He said he would wait for buyers who will pay face value in exchange for the state's guaranteed 3.75 percent return.

Last week, the Securities and Exchange Commission determined the IOUs -- so-called because they stand for "I owe you" -- are securities under federal law. That means anyone acting as a middleman between buyers and sellers must be a registered broker-dealer, and brokers cannot exploit desperate sellers by offering cut-rate prices below fair market value.

But that value has yet to be determined, as IOU holders and investors alike struggle to find their way through the state's financial wreckage.

SecondMarket, a registered online brokerage in New York, launched a service Wednesday to bring together California IOU buyers and sellers. Hedge funds, municipal bond buyers and wealthy individuals have all shown an interest in investing, said Jeremy Smith, the company's chief strategy officer.

Many small businesses hoped to hold onto their IOUs long enough to redeem them, but some contractors said they may reconsider selling their IOUs if the budget impasse lingers.

"If it becomes problematic for us, it's something we'd look into," said Frank Puliafico, whose company, Rayvern Lighting Supply Co. in Paramount, sells lamps and light bulbs to the state.

The department also worried that some unscrupulous sellers would try to pawn off fake IOUs as real, Dresslar said. This worried would-be buyer Mike Rhoden, who posted an ad on Craigslist offering to buy IOUs for 90 cents on the dollar.

"Have had zero replies and am not disappointed," Rhoden wrote in an e-mail. "Frankly, seems like a headache to do and am sure there are fraudsters out there you have to guard against."

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