California State Treasurer Bill Lockyer said U.S. and international financial regulators should limit trading of municipal credit-default swaps to help prevent speculative, or “naked,” trading of the derivatives.
Mr. Lockyer said in a statement Friday that absent an outright ban on speculative trading of credit-default swaps, regulators should adopt capital-margin requirements to reduce leverage and prevent abuses.
“The municipal CDS market, when used by bondholders to hedge risk, can benefit issuers by increasing demand for bonds,” Mr. Lockyer said. “But naked trading of CDS by investors who don't own California bonds poses a potential danger to taxpayers.”
In April, Mr. Lockyer asked Bank of America Merrill Lynch, Barclays, Citigroup, Goldman Sachs Group, J.P. Morgan Chase and Morgan Stanley to describe the extent to which they market the default contracts and asked them to explain how trading in the instruments affects interest costs on the state's bonds. California is the largest issuer of U.S. municipal debt and is the lowest-rated among the 50 states. The treasurer earlier sought a ban on speculative trading.
In May, Mr. Lockyer asked the banks to say whether they bet against the state with credit default swaps and how much swaps are sold to investors who don't own the debt. He said he was concerned that speculative trading could boost borrowing costs if the transactions create an unjustifiably negative perception of California's risk of default.
“Unchecked speculation opens the door to market manipulation that could artificially inflate perceived credit risk and increase taxpayers' borrowing costs on bonds,” Mr. Lockyer said Friday. “Reducing leverage opportunities will make it harder for speculators to game the system and hurt taxpayers.”
Moody's Investors Service grades California debt at A1, its fifth-highest rating. Standard & Poor's gives it an A-, its seventh-highest.