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Wednesday, March 24, 2010

Backstopping our way to disaster

One of my first blogs was on the financial disasters happening in California. As it turns out the circumstances in California are not unique and that the rigor which our state and local governments have addressed their financial houses has left much to be desired. The accounting assumptions have bordered on criminal, all based upon the ability of those in political office to be able to buy the most votes from monies stolen from future generations.

How could anyone behave so badly? The answer is because we it is our national pastime to subsidize those in the public and private domains who make bad decisions. In such an environment, those decisions look pretty good since those who make them are place in a win-win situation. Game the system and come out way on top. Game the system and get burned? No worry, the federal (or state and local) government will backstop you!

Backstopping in the form of insurance allows people and entities to take risks they could not take without the insurance. However, insurance has moral hazards which prompts people to take some risks they should not take. The more people are insulated from their stupidity, the more stupidly starts to look less stupid. In such an environment the most stupid thing to do is to not take advantage of whatever backstops are available.

Up until now, state governments, unlike the federal government, have generally been required to balance their budgets. This has acted as a brake on state spending. However, this is about to come to an end. The Federal government has figured out a way to assume the debts of the states through the Build America Bonds. When states borrow money, the feds are going to pick up about one third of the interest cost. This is a boondoggle which pays off virtually everyone! Wall Street will make a fortune on fees. States see their borrowing costs plummet. And what is a few hundred billion dollars added to the national debt (chump change). 

This is a direct inducement for states to change their economic policies to take on more debt. What part of this sounds like a good idea? This is like the housing bubble on steroids and meth-amphetamines. While investors are snarfing these obligations up in the great quest for returns now that Madoff is in jail, these returns may be based upon a similar house of cards. Apparently the bond markets are beginning to be skeptical of US debt and are pricing as a higher risk than private debt such as Berkshire Hathaway.

I can't say that I am surprised. Our economic engine requires that it remains juiced up on the financial equivalent of steroids, narcotics, and meth-amphetamines. It has been on steroids and stimulants for more than a quarter century. Now that the financial tachyphylaxis has kicked in, we cannot derive sufficient effects by dosing the financial steroids and narcotics through a single delivery portal. We need to delivery them po, IV, IM, and into every inflamed economic joint. For those of us who desire to remain clean and sober, we are just silly economic puritans. Are we ready for our financial 12 step program?

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