How to Cover Wall Street

A few weeks ago, California Governor Arnold Schwarzenegger said his state might need a $7 billion loan from the federal government just to keep making payroll and securing basic services. Virginia faces a $3 billion shortfall, our very own New York has a $2 billion hole in its budget and there are many more states facing huge deficits.

This wouldn’t be as much of a problem if state governments didn’t have state laws or constitutional amendments that demand a balanced budget. They just can’t run a deficit and be done with it (what would the federal government do if that was the case in D.C.?). Many states were in a precarious position with the slowdown in the economy and the credit crisis has only exacerbated their woes.

But what is bad for state governments could be good for investors.

Just like any huge enterprise, state governments need to borrow money to keep running smoothly. Many of the largest states in the United States fund a lot of their garbage collecting and street cleaners by issuing short-term bonds of less than a year. And with the credit markets clogged up the amount of interest (or the coupon) they have to offer on their bonds is going up. It’s a necessary step because a state like California just can’t stop paying the 340,000 people it employees in its public schools, so it’s going to have pay more to borrow.

So this means those doing the borrowing are going to make more coin. And while New York and other states have put off doing a huge bond issue, California started one today in which the state hoped to sell $4 billion worth of bonds. Bloomberg reported earlier today that investors had bought half of the bonds.

And why wouldn’t they?

The yield on sixth-month treasuries are at 0.93%. For California bonds maturing in May the coupon rates were between between 3.75 and 4.0 percent and for ones maturing in June the rate was 4.25 to 4.5 percent. Last year the state sold these kinds of bonds at 3.37 percent. So lets say that that California’s coupon rate is an average of 1 percent more than last year. That means the state is paying about $25 million (hard to figure because I don’t know how many of each kind of bond was sold) more in interest to borrow $4 billion now than it would have paid last year. And the state is only borrowing the money for less than a year.

One investor didn’t hesitate to take advantage of California’s financial woes. Gov. Schwarzenegger bought $100,000 worth of bonds today. For a guy who is worth a reported $100 million, the bond buy isn’t a bold move, but it looks good politically and when he collects his coupons in the next few months he probably won’t mind either.

And just for a good laugh, here is the youtube clip of the Governator at the 2004 Republican convention.