NOTE: FIVE THINGS WILL RETURN MONDAY, JULY 20.

1. The (Eventual) Upside of Risk Aversion

They say four years is the equivalent of 1.2 days to a housefly. If you think about it, surviving 1.2 days is quite an accomplishment for a filthy creature known to carry more than 100 separate pathogens. Yet flies manage to live for nearly a month, mostly because they are fast moving and extremely difficult to chase down and kill... much like the cycle of credit in the economy. This is where we were four years ago:

Blank Generation, Minyanville, June 7, 2005:

"I belong to the blank generation and I can take it or leave it each time."
Richard Hell “Blank Generation”

"These blank checks arrive virtually every day. They arrive via email and priority mail. They arrive tucked between the pages of the Sunday newspaper, plastered to my car windshield, bannered across the Web sites I visit. Some of these blank checks are for that family vacation we didn’t save for, or that home improvement project I meant to tackle last year but couldn’t fit in the budget. Others are for computer equipment, home appliances or, ironically (and perhaps misleadingly), debt reduction.

Twenty years ago it was almost unheard of to have the kind of access to credit we have now. The New York Times, in its ongoing three-week series on class in America, observed recently that the barriers between classes have become blurred, making it more difficult to identify occupants of the lower, middle and upper classes. Whereas possessions, such as clothing, automobiles, watches, etc., used to act as class signifiers, it is becoming increasingly difficult to discern class based on possessions alone. According to the Times overview, “Factories in China and elsewhere churn out picture-taking cell-phones and other luxuries that are now affordable to almost everyone.”"

We've come a long way. When that article was written the personal savings rate was near zero and Americans were gorging themselves on easily available credit. It wasn't a matter of what we were piling up debt to acquire - the acquisition was secondary to the simple act of racking up debt itself. If you weren't borrowing, you weren't living. This was as true for the man on the street as for the pie-in-the-sky corporation where he worked.

That's grim stuff and reputations were made disseminating that viewpoint to anyone who would listen. But let's face it: few were. Very few. Now, four years later, a mere 1.2 days to a housefly, it's all anyone wants to hear.

But that's the last battle. We are nearing the point of recognition, and beyond that risk aversion is an upside. Personal savings as a percentage of disposable income is now safely above 5% and nearing the average of the past 50 years. It's a start. Meanwhile, bank credit is contracting at a 5% annual rate.

While that is evidence of the secular shift we're seeing in consumer behavior, and fuel for the ongoing deflationary debt unwind, it's a step in the bullish direction. We can't have it both ways. If the orgy of credit and non-productive consumption was bearish for the future in 2005, the return to more normalized consumer behavior, an increase in savings and reduction in borrowing, is bullish for the future in 2009.

2. Meanwhile, for the States, the Worst is Yet to Come

The toughest part to swallow about the potential bullish shift in consumer behavior is how much more difficult it's going to get on a local level first. Let's not look at this through the housefly's multiple 1.2-day-old lenses. The process of debt destruction and economic decline will have to run its course. And on the state and local level it is going to continue to deteriorate.

The Economist magazine recently ran a piece, “Happy New Year,” which put some numbers to the budget pain facing states across the country. According to the National Association of State Budget Officers, total state spending will drop for the second consecutive year and by the most in more than 30 years. At least 42 states have already slashed their budgets so far this year. Minaynville's Tal Pinchevsky recently looked at the bizarre ways states are trying to squeeze blood from a stone and ease growing budget woes.


3. How Bad Is It?

So how bad is it? Let's take a quick look at the worst case, California. The state will take the bizarre step of issuing IOU's while lawmakers squabble over the state budget. The IOU's will pay an interest rate of 3.75%. Who gets the IOU's? Thousands of businesses and individuals, covering everything from tax refunds that are owed to services and goods.

According to Bloomberg, Bank of America (BAC) said last week it would accept the IOU's from its customers through July 10. Wells Fargo (WFC), JPMorgan Chase (JPM) and Citigroup (C) said they will accept the IOU's (which go by the more fancy name "registered warrants") through July 10 as well.