In my last post, I was starting to think that the banks had a really sweet deal in this crisis.  First they get to take first cut of profits on mortgages that actually weren’t profitable, then they can take cheap loans from the government.  If they wanted to put those cheap loans into safe profit margins, they’d just have to use the federal government’s money to buy up state bonds & IOUs.  But hey, who wants a few measely percents in interest?

The big stinger is that right up until these IOUs hit the street, these banks had announced their willingness to pay face value.  Once they were printed up, distributed, and ready for deposit – the big banks decided they would stop buying them after Friday.   Companies bailing on the bailout include:  Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co.  You may recognize these guys as some of the biggest beneficiaries of recent federal bailouts in the financial sector and the ones currently sending bidders to the discount window.

So what inspired the change of heart?  Was it Fitch’s recent downgrade of California’s debt payment prospects?  Or was it the fact that they realized IOUs were already being exchanged at a discount off face value…?

The state has announced that they intend to honor interest payments and redemption of the IOUs bought on the market, so the refusal of banks to take them as deposits means they’ll be left to the market price.  Check cashing establishments and speculators are reportedly scooping up the certificates for about half of face value.  In October, they’ll be able to sell these back to the state at face value plus interest!

Once again, the government has intervened to “fix” an economic mess it created.  The result?  Anyone who lives check to check gets sold out for pennies on the dollar, and those with plenty of cash lying around have a guaranteed profit opportunity.  I’d say I’m surprised, but this seems to be the contemporary standard of political-economy.

So Goes the Nation

It has often been said that California is a trendsetter among states – anything that comes to pass in Cali will eventually find its way throughout the nation and into federal policy.  From social movements to Hollywood and internet first-adopters, there’s always been a sense that the future was already happening on the west coast.

If this maxim, “As California goes, so does the nation” proves to be correct again, then the rest of us had best pay some attention to the current financial crisis and how the politicians have chosen to deal with it.

Faced with rising costs and declining budget revenue, they’ve indirectly chosen a solution out of fear of making tough decisions.  The printing presses have literally been fired up, and the state is issuing IOUs.  While these are technically bearer bonds paying at 3.75%, the state is rumored to be printing them on dark green paper and encouraging banks & businesses to treat them like cash.

And How Far We’ve Gone

For most of America’s history, cash has been backed by some sort of commodity.  Gold has long dominated as a medium of exchange, and silver has also been used as payment for paper notes.  FDR figured out to devalue the dollar for a more flexible monetary policy, but Nixon figured out how to get Americans to give up all the tangible value of their money itself.

With no commodity backing the currency, the only thing that stops California from ordering a few trillion from the Treasury is political will and a fear that we’ll eventually go “too far” and ruin the dollar’s reputation as a reserve currency.

Let’s be honest anyway, someone who had invested in dollars under the gold standard would be brutally unprepared for something like retirement.  Other nations have been sending “stuff” to America in exchange for these dollars, so they’re the ones taking the investment losses.   Some have started inflating their own currencies in defense (see Japan’s carry-trade), some are also openly calling for a new monetary regime. With financial heavy-hitters like Russia, India, Brazil, and China meeting to discuss alternatives to the dollar, this dollar reserve reckoning day seems like it may be closer than we’d like.

So instead of being paid in a dollar that is literally “as good as gold,” residents of California will be receiving a debt promise – and the interest on that debt is going to come out of the future taxpayer’s pocket… somehow.

Heads or Tails?  The Bank Wins

If the government itself is in a cash crunch, who has the liquidity on hand to give state workers real cash in exchange for their state IOUs?  Conveniently, we’ve just pumped a few trillions of liquidity in to the banking system and these banks are more than happy to trade IOUs for dollars.  By some accounts, transfers and insurance policies have added five or six trillion dollars to banks’ balance sheets, and they’ll be able to use this money to buy up as many IOUs the states can print out. Of course, the banks were supposed to use this TARP & bailout money to extend business & consumer credit, but those individuals and small groups seem like a big risk compared to the state itself…

Eventually, California will figure out how to raise taxes or cut services (or probably some combination of the two).  In the meantime, the banks will collect a nice stable interest payment in a chaotic economic environment. Indeed, we’ve fallen a long way from paying workers out in gold – we’ve leveraged our paper treasure against our own citizens for the benefit of the banks.

Can We Break the Spiral?

Financial dissent is our secular heresy:  of all the thoughtcrimes, perhaps none is so shocking as questioning the nature of what we call modern capitalism.  As a society, we have invested so much collective faith into this abstract concept that we are unwilling to reform the root causes and financial power centers – even if they are relatively new institutions that conflict with older parts of our national identity.

Its never even clear what it is that we have faith in.  Is it the politically connected speculators or the regulators handing them our tax money?  Either way, solutions must be kept on the edges of their playground – suggesting significant core reforms is a sure-fire way to be uninvited from offering your opinion next time.  As long as this paradigm rewarding blind faith holds, things will continue to decline in a slow and methodical way.  At the next wave of mortgage resets, there will be another rather steep cliff, but odds seem high that we’ll cushion the banks and resist substantive changes.

Its not a great outlook, but I don’t believe anything can get significantly better until our so-called leaders take on some of these tough decisions and set up institutions designed to promote general wealth and opportunity.  Fundamental changes in our approaches to credit and money has to pay bigger dividends than bailing out the same bank for the fourth time…

I’ve mostly been able to avoid flying, so the recent trip to Ireland was my first experience with the changes since 9-11.  The last time I had flown before that was in the summer of 2001 – and that was enough security hassle for me so I rightly guessed the modern scene would be a total nightmare.

The most obvious problem is the scope of what they’re attempting:  a full inventory of every passanger and his or her belongings.  While they spare no expense in attempting to verify every single thing, they do spare time.  Everyone is being rushed through crowded corridores and I find it hard to believe that sneaking things through would be impossible due to the simple fact that so much is being examined in such a short time.  Sure, large metal objects will be found, but that was the case back when the metal detector was the only standard exam.

Its even possible that more time could be spent inspecting cargo and passangers by killing redundancy.  When leaving Dublin, I noticed that we had to pass through four American security checkpoints before boarding and leaving the plane.  Why is security searching people who just passed through U.S. security?  Do they think we picked up some terrorist hitchikers when we were seven miles above the ocean?

Incidentally, this is when my Irish whiskey became triple sealed.  First of all, they come in sealed bottles from the duty-free shop.  Now although the duty-free shop is after Irish airport security, it is before American airport security.  This means the sealed bottles of whiskey had to be sealed into a bag and stamped by a U.S. security guard to get on the plane.  That’s two seals but that’s not good enough!  When we landed in Philidelphia, we were informed that nothing from duty-free shops would be considered secured and we’d have to get them … yes … inspected and stamped by security.  This led to the third seal:  boxing up my sealed bag of unopened whiskey to be sent with checked baggage.

The establishment of redundant security checkpoints has affected the layout of several airports.  Passangers are corralled through long hallways and unused basements, often walking for an hour in a big circle rather than be allowed to move inside the secured zone of the airport terminals.  U.S. Airport Security guards in Dublin aren’t trusted in Philidelphia, and U.S. Airport Security guards in Jacksonville aren’t trusted in Charolette.  Don’t even get me started on London – they take distrust to third world levels.

When I flew in from Europe in ’01 it was a lot different.  Security met us at the terminal and inspected for produce (and I guess drugs, but all they got were apples).  Customs was right outside and they singled me out for heavy inspection (probably because I look like a hippy).  Anyway, despite that hassle, it was a lot less infuriating then the current security theater.

Today’s guards don’t have the time to inspect suspicious looking people like me, yet everyone is subject to standing in lines & running through hallways for more time than it would have taken to do so so they can wave you through some xray machines displaying a blob of grey lines.