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Municipal Finance, the Third Derivative


As goes California, so goes the nation.

Seems like everywhere I turn, someone else is talking about our current rally as "the second derivative" -- where less bad equals good.

Maybe it is just me, but nothing right now feels particularly good -- at least not relative to the years leading up to this crisis.

Eighteen months ago, I wrote about "the end of the age of aspiration" -- that golden era when our lives appeared to be limited only by the size of our wants.

Since then, we've watched as Fannie (FNM), Freddie (FRE), and over 100 banks have failed: The "ground zero" of where our greatest want -- big, new houses - met our greatest excess -- leverage.

Then the second derivative hit, resulting in the bankruptcy of General Motors (GPM) and Chrysler, owing to that new car every 2 to 3 years, excess debt, and unaffordable retiree benefits.

But I would offer that today officially begins the third derivative: municipal finance. This is where our delusional desire for low taxes and extensive public services collides with an unreconcilable maelstrom of high unemployment, lower housing values, and truly unaffordable retiree commitments.

I don't profess to know how this one will resolve itself. As an interim step, California has announced that it will be meeting its obligations using script -- IOUs. I don't know how long employees and vendors are willing to work for nothing more than a promise. But I do know that it's entirely unsustainable.

But I can't emphasize how important it will be to watch this one. To date, as bank executives and auto industry leaders have thrown up their hands, the federal government has stepped in to fill the void -- albeit with unintended consequences.

How willing Congress and the White House will be to save California is unknown, but I don't think it's an exaggeration to say that "As goes California, so goes the nation."

And, not surprisingly, with unintended consequences.
No positions in stocks mentioned.
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