Anthony Gregory recently wrote an article lambasting the Republican Party, particularly the politics of debt in California. Schwarzenegger was one of the key players in getting the Wall Street Bailout passed; he wailed about the dire straits his state was in with respect to the credit market the morning of October 3rd, coincidentally the same day that the House did their do-over vote on the bailout. California did indeed get its loans. As Mr. Gregory points out, it would seem that bankrupt states should be un-creditworthy. But they always have the taxpayers to milk, so re-payment is u201Cguaranteed.u201D
NPR’s All Things Considered dedicated their show last Friday to how the so-called credit crisis is affecting municipal bonds. Of course, the politicians are not to blame for irresponsible spending based on debt: u201CThe problem [is]…a new way of issuing bonds… called variable-rate bonds.u201D
u201CThe kicker of this whole thing: the municipalities are only doing what they’ve always been doing. Issuing bonds and paying them back with interest…It’s the institutions that were supposed to guarantee them — the insurance companies and the banks — that have gotten in trouble.u201D
There are two obvious questions that are not asked or answered. First, why did investment in sub-prime mortgages and risky debt instruments become so popular? When I first started listening to Murray Rothbard lectures, I realized that economics is not complicated. It is not beyond the understanding of the average citizen. We do not need experts to shield us from the burden of observing everyday truths. Hungry for more, I picked up Rothbard’s u201CWhat Has Government Done to Our Money.u201D I’ve read this book twice, and, honestly, I still don’t fully understand how banking works. What I do understand is that the government has made money and banking so complicated that most people will not have the patience to try to figure out what government has done to our money. So we do need experts to explain this convoluted system to us. Most economists do not understand money and banking, but, thankfully, there are a few hundred at the Mises Institute that do. And these scholars have a beautiful answer to the question above: The banks and insurers were given false signals about the state of the economy in the form of state-controlled monetary policy. Money and banking is not inherently complex, but the government has made it so that people in the banking industry cannot make accurate entrepreneurial guesses about how to manage investments.
The second question is: why are municipalities so dependent on debt? When discussing Philadelphia’s debts, the journalist/narrator says, u201CCities issue bonds all the time. In fact, they wouldn’t exist without them.u201D This quote really struck me. I think it is this thinking that Schwarzenegger was counting on when he pushed for the bailout. If California can’t pay its bills, what happens? Will it disappear? Literally fall into the ocean never to be seen again? Of course not! It simply goes bankrupt and some major changes must happen within the government. Of course, Schwarzenegger’s job is put in jeopardy, but the people, geography, architecture and all of the other aspects of California — that is, everything that defines California — will remain.
So is it true that cities u201Cwouldn’t exist withoutu201D bonds? A city is simply a densely populated area. A city is defined by the people that inhabit it. The city government is only one aspect of a city. A more accurate statement is that city governments may not be bloated and powerful without bonds. (Besides, I’d guess that Caesar didn’t float bonds for Rome, but I’m not a historian…)
But even bonds can’t prop up the city government forever. Economics is not difficult. You can easily imagine the city government finances as those of a private individual. I know someone who spent years living on credit cards. He had figured out how to pay off one debt by borrowing and creating another debt. It worked for a while, and kept him and his family fed, but he knew it was unsustainable. As soon as he was able to get back on his feet, he paid down his debt through saving. As long as he continued to live on debt alone, any small unexpected event — a child’s injury, a storm causing damage to the car — could send his family into a state of starvation. Likewise, debt can boost up a city government for a time, even a long time, but it can also bring the government down. Such as when there’s a bust caused by Federal Reserve policies.
In another segment of the same All Things Considered broadcast, there is a great quote: The Irish government told Depfa that they were u201Ctoo big to save.u201D Although Ireland did bail out some banks, and Germany ultimately bailed out Depfa, I think we should try our best to replace the phrase u201Ctoo big to failu201D with u201Ctoo big to saveu201D whenever possible. Such as, u201CCalifornia is too big to save.u201D (Remember: it won’t sink under its own weight if we don’t save it.)
Kathryn Muratore [send her mail] is an Assistant Professor of Chemistry at American University. She holds a Ph.D. in Molecular and Cell Biology from UC Berkeley.