A Modest Proposal to Save California

With the State of California presently pumping out $3 billion in unconstitutional IOUs, we suspect that a more impressive meltdown of the State's government is not too far off. It seems unlikely that any mixture of creative accounting and tax schenanigans will be able to stave off the collapse of the State's tax revenue, nor its downgrading debt rating. Unless Governor Arnold Schwarzenegger manages to both get the California legislature to accept his drastic cuts to the State's outlays - as well as pushing for even deeper and sweeping cuts - California will likely perform a sovereign default, and experience a collapse of the Government's services.

But, as with most things, it really doesn't have to go down like that, and to that end we have an idea: de-State-ify California, and convert it into the District of California. We think the move could go, as Bob Newhart says, something like this:

The Federal Government forces bond holders to swap California's debt for fresh Treasury debt at face-value, or perhaps a token premium. With that move complete, the Federal Government would then dissolve the State Government, and place the political administration of California directly under the authority of Congress. As we understand it, this would convert California into a Territory (which is how the District of Colombia is classified). In order to get the residents of California to feel happy about this move, the Congress could pass a Constitutional amendment allowing territories - like the District of Colombia, and possibly the District of California - to vote in elections of Representatives and the President.

This move would not be without benefits to both parties (i.e. California and the Federal Government): Californians could conceivably see lower taxation, as there would be no parallel State/Federal services, such as welfare... but we would count on that one too much. The Federal Government would be the bigger winner, because California would lose its Senators. That may not seem like such a big deal, but if turning a State into a District is successful, or at least not a total catastrophe, the Federal Government would likely perform the act on several other failing States. With fewer and fewer Senators, an argument could be made for the dissolution of the Senate, and the transfer of the Senate's powers to the Executive or the House of Representatives. Such a move could be dressed up as a 'drastic change to increase efficiency in Government, and reduce public expenditures.'

Be that as it may, if the Federal Government were to take over California directly, it would at least stave off the embarrassment, and potential fallout, from having a State default on its debt. It would also be a shrewd move for the Federal Government, for a somewhat complicated reason. As, in theory, the Federal Government is the representative of its constituent nations (as in a Republic), the credit rating of the Federal Government probably would be affected negatively by a Californian default. Such an effect would have a concurrent negative affect on the Federal Government's spendthrift ways. Ergo, prevent a Californian default at all costs, to protect the Federal budget.

Or... the Federal Government could just fork over a tonne of money to California, since Michigan has already gotten its own, private bailout. We can only remark on how well it seems to have worked.

Trillion Dollar Welfare

We're certain that you have seen the recent flap about Ms. Nadya Suleman, from whose loins recently sprung a brood of eight premature babies. We extend our condolences to the people of California, whose tax-dollars will go toward the bill Ms. Suleman's fourteen children are piling up.

Honestly, we have to agree with the more negative views of Ms. Suleman's irresistable urge to breed: she is patently unable to feed and care for her previous six children, much less the additional eight. She should never have had any children, since she is unwilling or unable to work. If we were more impolitic, the term 'welfare queen' would come to mind. Thomas Malthus never seems quite so right...

But, we really must protest about Ms. Suleman's unfair treatment. Or rather, the unfair treatment of the bankers, the car companies, and the United States Government. Ms. Suleman's spawn will cost California tens of millions of dollars... but the unspeakable excesses of Wall Street and other scams are costing trillions, not to mention the integrity of the entire world banking system.

Let us be perfectly honest: Ms. Suleman is a leach, sucking money from productive people so that she can breed; Mr. Ben Bernanke, Mr. Bernard Madoff, Messrs. Timothy Geithner and Hank Paulson, Jr., and the rest of that lot... they are worse that leaches. They -- the Investorati -- are internal parasites, consuming everything of value from within, leaving only a dead husk behind.

Ms. Suleman rightly deserves the scorn she is receiving. But the Investorati deserve far, far worse than what she is getting. A sense of proportion must be kept in matters of welfare and bailouts; TARP and the $787 billion stimulus package is welfare of a grander scale than anything Ms. Suleman could ever absorb. American citizens should be rightly offended by Ms. Suleman, and frothing with pure rage at the bailouts.

Avoiding Conceptual Traps

A depression is a confusing thing. Many things which were apparently normal one's whole life aren't happening any more. Economic growth and 'progress' seemed like orderly, lasting processes. Disorder and breakdown now abound. There is a tremendous temptation to renormalise observed events into patterns that just aren't there. Patterns create a sense of place and order; lack of them causes anxiety.

We would like to take a look at a few conceptual traps that will ensnare the unwary. These traps are created in one's mind in a desperate effort to carry on as usual in the face of circumstances that require a change of strategy. Change is difficult - the 'same old' is easy.

The Value Trap is claiming many victims even as we write. The Value Trap happens when the prices of an asset falls to a level which seems like a good deal. Buyers who may have sensibly avoided 'bubble' pricing, now buy what appear to be bargains. Unfortunately, prices keep falling. Buyers of houses with mortgages find themselves soon 'under water', with their downpayment wiped out. It is imperative to adjust one's frame of reference as to the value of a prospective investment, and if something seems like a good deal - beware.

Institutional Security is misplaced confidence in employers, pension funds, governments, and so forth. Many of these institutions are in really terrible shape financially, and will not be able to deliver on their promises (the State of California comes to mind). There, a lot of people have been banking on long-term employment, contracts, and pensions that will not last. Do not assume even that U. S. government, or any other national government, will fulfill its obligations. It is critical under the present circumstances to develop self-reliance. Could you support yourself if left to your own devices? If presently self-employed, do you have a broad base of customers and suppliers?

The Sound Dollar Trap results from putting one's faith in the U.S. Dollar (or any other currency). Dollars steadily lose purchasing power (for a discussion, see this article and pay special attention to Figure 1). Currencies are themselves institutions (in a broader sense) that are unquestioned, background 'realities'. Keeping some currency is a necessity for most transactions, but it is not a vehicle for any kind of long-term savings or investment. Just because it may have done less badly recently than other assets, does not make it in any way 'good'.

Bailout Rebound is our term for the notion that "happy days are here again" due to some new government program, or bailout. This manifests itself in investment markets as Bear Market Rallies - upward price movements on some 'good news' in spite of the pervasive trend downwards. One wants to believe that the 'bottom is in', that markets are recovering and it's time to invest, or buy that bigger house one has been wanting. One wants to latch on to any sign of an emerging trend towards recovery. In the 2007 Depression there will be many bailout rebounds, false dawns followed by greater darkness.

A variant of the 'rebound' is Dodging Bullets. This is a type of wishful thinking that results from surviving incremental adversity. Just because you survived the first round of layoffs doesn't mean you'll make it through the next. If a mortgage has been renegotiated, the borrower will still likely default (see this article). While maintaining a positive attitude is always beneficial, do not delude yourself with survival bias. Remember that we tend to hear stories of survival only because non-survivors are not able to tell their stories! Things look bad all around, and they are probably going to get worse. The 2007 Depression is going to mark a major shift in everyone's modus operandi. Vigilance and caution are the watchwords of the hour.

Finally, we would advise bewaring the possibility of a Crack-Up Boom. A crack-up boom happens when the people lose faith in their currency due to accelerating inflation. When severe inflation is universally acknowledged, people will buy things - anything - to get money out of their hands and into something that won't lose as much value as the money does. This repudiation of currency creates an enormous demand for goods, and the consequent increase in production looks like a return to prosperity. But don't be fooled if this event comes to pass. It would be but a phase of the 2007 Depression as it morphs into a hyperinflationary depression.

Perceptual Wealth

Much of financial news of recent note has typically been about how much money has been sucked into a black hole. People bemoan the falling value of their 'nest egg' real estate; stocks hopped onboard a time machine and revisited the Nineties; California real estate is already in the Nineties, and seems to have a hankering to see some disco. There's a distinct possibility that some financial sharkskin suits might be spotted in the near future, and we wouldn't rule out a resurgence of the Zoot suit.

But what, really, has been lost? In our examples, and indeed in general, money hasn't actually gone down a black hole: all that has changed is the hypothetical price tag on a given investment. Nothing changed physically about the houses in California (usually); the same can be said for stocks. One day they were value X, and the next they were value Y... the bad news: Y was less than X.

Such fluctuations are normal in a market's valuation of a given 'thing,' and are to be expected. Just because 'the market' says a certain Californian condo appraised at $450,000 doesn't necessarily mean someone will actually buy the place. The condo is worth what someone will pay, and not a cent more. Trouble sets in when people confuse a market valuation with 'money in the bank,' and spend $400,000 as if they had already sold the condo.

We suppose it's all well and good to do this when the market is forever going up... but surprise! No market is immune to the inevitable downturn, and now the average Californian real estate speculator is 'under water' (i.e. owe more than their properties are worth). They're saying they've lost money, but have they really? They didn't sell their property, but yet they spent like they had a big pile of cold, hard cash. They thought they were wealthy, but clearly weren't... so what did they have?

Perceptual wealth, dear Reader; the perception of wealth, without actually being wealthy. These real estate speculators (a.k.a 'homeowners') truly believed they were wealthy, and so they spent and lived as if they were wealthy, but in the end what made their 'wealth' wasn't real. It was an opinion, a valuation; it was what someone said the investment was worth. Writ large, the real estate bubble more resembles a confidence scheme, but it all began with someone feeling wealthy because they bought a condo in California.