Just say “No” to the Terminator?
by Tom on June 1, 2009
in Market Musings, banks
Peter Schiff has a very good column at Financial Sense about California seeking a bailout. I’ll summarize very briefly and then read what he wrote below (and go read the whole thing if you’d like…..)
If the Federal Government bails out California:
- Tough decisions won’t be made that need to be made in California.
- Other states will be encouraged to seek bailouts from President Obama thereby increasing the amount of debt the government (US) is obligated for. Can you say, “Moral Hazard?”
- From a technical standpoint, Federally guaranteed bonds from the state of California would be a better deal than US Treasuries because they are exempt from state income tax. So what? So the LAST thing we need is competition that can take demand away from Treasuries since we are flooding the market with Treasuries.
One other thought. I’d encourage you to not only read Peter Schiff’s article, but also read it and substitute “California” and states with any assortment of other terms. Words like:
GM and auto industry
AIG and insurance industry
Citigroup and the banking industry
The problems and challenges are the same and I think that this quote summarizes the article quite well:
“Unfortunately, given Obama’s recent string of unwise economic
decisions, it’s hard to imagine that his judgment will suddenly improve.“
Tom Vanderwell
“Obama Should Tell California to Drop Dead” by Peter Schiff, FSU Editorial 05/29/2009
During the height of New York City’s financial crisis in the 1970’s, President Gerald Ford had the good sense to turn down Mayor Abe Beame’s request for a federal bailout. The refusal prompted the famous New York Post headline, “Ford to City: Drop Dead.”…..More than 30 years later, as California Governor Arnold Schwarzenegger makes a similar plea to Washington, I hope President Obama will show similar restraint. Unfortunately, given Obama’s recent string of unwise economic decisions, it’s hard to imagine that his judgment will suddenly improve……
……Governor Schwarzenegger’s claim that a federal guarantee is not a bailout is ludicrous. No one in the private sector will lend California any money because the state can’t pay it back. Just like AIG and GM, it needs federal help to stay solvent. And although the Federal balance sheet is in far worse shape than California’s, there is one crucial difference: Washington has a printing press, and Sacramento does not. With the ability to pay off debts with newly created funds, a federal default is not a concern……
Similar to the reckless behavior that resulted from federally guaranteed mortgages, federal guarantees on state debt will counteract the market’s attempt to force states to act responsibly. As the market accurately prices-in the heightened risk of default, California faces staggering increases in its borrowing cost. Under normal circumstances, this pressure would force the state to act prudently now to diminish the risk of a future default. However, by allowing California to evade the “bond market vigilantes,” the stage will be set for much bigger losses……
The moral hazards created by state bailouts are tremendous. With federal guarantees given to profligate states, those states that had shown greater fiscal responsibility will face higher interest rates – as their bonds lack a federal guarantee. This creates the perverse incentive for all states to act irresponsibly.
