California Bankrupt, If You Live in California, Here's What You Do...Interest-Rates / US Bonds Jul 07, 2009 - 08:28 AM GMT
Dr. Steve Sjuggerud writes: Would you lend money to someone who is completely broke and in a mountain of debt... and only demand 3.75% interest?
That's what California is forcing many people to do today.
California is out of money. But it still must pay people. So it's paying in "IOUs" instead of cash. By the end of this month, California will have handed out over $3 billion in IOUs. These IOUs are only supposed to last for a few months. And they pay a 3.75% annual interest rate.
How will this end?
Some investors are getting excited – they earn interest AND can potentially buy these IOUs at a discount to face value in exchange for cash.
Me? I have no interest in these things. I've seen this exact game before... It happened in Argentina in 2001. The lesson was this: You don't want to lend money for a tiny bit of interest to a broke state that has no problem changing its laws on you.
In 2001, the province of Buenos Aires ran out of money. So it started issuing IOUs called "patacones" that paid 7% interest.
What's a patacon? It looked like money, but it matured a year in the future. The man on the street was confused... Many merchants flat-out refused to accept patacones (though McDonald's offered a special "Pata-Combo").
"One peso buys a cup of coffee or a newspaper... but what will you be able to buy with one Patacon?" an Argentine woman asked the Wall Street Journal in 2001. She had no idea how prophetic her words were...
Long story short, a U.S. dollar's worth of patacones held in late 2001 were worth about 30 U.S. cents a year later at maturity, after the Argentine peso crashed. And that's much better than money issued by other Argentine states... For example, the "federal" issued by the province of Entre Rios north of Buenos Aires was worth maybe 10 cents on the U.S. dollar a year later.
Now, I don't expect a repeat of Argentina's crisis in the States. I don't expect the California IOUs to fall to 30 cents on the dollar.
At the same time, I'm not interested in giving cash today for a patacon, er, a California IOU that promises to pay me back at some future date with only a small amount of promised interest for my troubles.
The government of California is broke. If you're unfortunate enough to receive California "patacones" try to get rid of them. Use them to pay your taxes, sell them to the knuckleheads on Craigslist... do whatever you can.
But don't hold them. The historical record of broke governments issuing IOUs doesn't offer much promise. The "reward" of 3.75% interest versus the risk simply isn't worth it.
Get rid of your California "patacones" if you get 'em...
P.S. These IOUs are different than municipal bonds. Some California municipal bonds actually could do just fine – particularly "revenue" bonds, which pay you back directly from the project the bonds financed, like a toll road.
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