By Colin Barr
April 22, 2010

The biggest banks can be blamed for many things, but causing a debt crisis in California isn’t one of them.

So concludes a report issued Thursday by the state’s treasurer, Bill Lockyer. He said data collected over the past month shows the big derivatives-dealing banks aren’t conspiring to send the state’s bond yields higher.

The report says that since 2007, the big derivatives-dealing banks – Bank of America (BAC), Barclays, Citigroup (C), Goldman Sachs (GS), JPMorgan (JPM) and Morgan Stanley (MS)– have done $27.5 billion worth of credit default swap trades tied to the state’s general obligation, or GO, bonds. Credit default swaps allow users to bet that the underlying bonds will perform poorly or, well, default.

But as of mid-April, the derivatives held by the six banks were worth a net $241 million – showing that the banks themselves aren’t taking big positions against the state.

“The data suggest the banks themselves, during the period covered, did not bet against the credit quality of California GO bonds,” Lockyer said.

Lockyer opened a probe of the issue last month. He fairly seethed in letters to the CEOs of the major banks that wide spreads on California swaps  “wrongly brand our bonds as a greater risk than those issued by such nations as Kazakhstan, Croatia, Bulgaria and Thailand.”

Of course, California pays high rates largely because the state’s budget is a mess and its political system on the verge of a breakdown. The spread between the rate California pays on 10-year general obligation bonds hit an all-time high last year, Lockyer said.

At those rates, he estimated that selling $1 billion of debt cost the state $380 million more than a state that could issue its debt at the going municipal market data index rate.

The news is welcome for the banks, given that Goldman Sachs is facing Securities and Exchange Commission civil lawsuit over its handling of a subprime-related debt sale, and the Senate is moving forward on financial regulation reform that could hamper one of the banks’ most profitable businesses.

But congratulations are hardly due. Lockyer said he will ask the banks to disclose which of their clients are betting against California in the swaps market without owning the underlying bonds.

All in all, it seems clear that Lockyer has doubts whether the $215 million the state has given Wall Street to run bond offerings over the past three-plus years was well spent.

“Taxpayers’ primary operating principle should be this,” Lockyer said. “Look out when Wall Street says it’s looking out for you.”

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