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Saturday, May 30, 2009

Schiff to CA: Drop Dead!

Peter Schiff says no to a federal bailout of California:
California, like many states, expended its bureaucracy as the nation’s bubble economy inflated. When condos flipped like hamburgers and homeowners flush with equity spent like lottery winners, extra tax revenue flooded into Sacramento. However, instead of saving the money for a rainy day or paying off prior debts, the state government simply ballooned its spending. Now that the bubble has burst, and revenues are severely depleted, it is time for California to reconsider its excesses.

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.

However, if Obama comes to the rescue, none of the needed cuts will be made. Instead, California will continue to operate its bloated bureaucracy and will be in constant need of more bailouts. In other words, if Schwarzenegger gets his bailout, look for him to utter his famous line – “I’ll be back.”

But it’s not just Schwarzenegger who will be back, but governors from all the other states as well. After all, if the Federal government bails out California, by what right can they deny similar aid to other states? The bailout will send a clear message that states do not need to cut spending.

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.

Just as government-guaranteed mortgages lead the market to make overly risky home loans, federally guaranteed state obligations will set the stage for yet another crisis.
-- from "Obama Should Tell California to Drop Dead" by Peter Schiff.

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