On Monday, Bill Lockyer, Treasurer of the State of California, sent letters to six major banks that underwrite the state’s municipal bond sales requesting information on their involvement in selling credit default swaps (CDS) on the State’s debt. Recipients of the letters include:

The letters begin by stating reasons that there is no need to participate in CDS on the State’s debt, including high priority of debt servicing (second only to school funding), continued appropriation of funds for general obligation (GO) debt servicing, security-plus backing of GO bonds, and the State’s “spotless record” of paying its debt on time and in full. The letters then express concern that the perception of risk caused by transactions in CDS on state debt could adversely affect pricing of the state’s bonds when they go to market.

“I have no preconceived notions about the effect of CDS trading on California GO bond prices, or about your firm’s activities in the California CDS market,” Mr. Lockyer said in the letters. “I do, however, worry about firms selling our bonds, on one hand, and trading CDS on our bonds, or otherwise participating in that market, on the other,” and adding that “taxpayers have a right to know this information.”

Attached to the letters, and available through the above links to the letters, was a one-page document requesting, from the underwriters, information about the firms’ trading activities in municipal and State of California CDS; credit analysis/marketing information distributed, by the firms, to clients regarding CDS in general and California CDS specifically; the firms’ views on how California CDS trading has effected the State’s bond sales and borrowing costs; and the firms’ outlooks regarding the municipal CDS market and, specifically, the California CDS market, over the next two years.