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 Journalin 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...
Good investing,
Steve
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.
It's time to check in on one of the "must watch" charts for the trader: The all-important S&P 500.
Most folks like to look at the Dow Industrials and say the market is "down 10 points" or is "up big today." But seasoned investors watch the S&P 500 index. It's a wider gauge of the market. And as you can see from today's chart, this gauge is near a short-term "line in the sand."
From early March to mid-June, the S&P enjoyed a historic 42% bounce. This bounce took the S&P to a high of 946. But since that high, stocks have displayed "soggy" behavior. The market has given back a portion of that 42% gain... and is camped near an important chart level: the May low of 882.
The 882 area is where the last set of heavy "trench warfare" occurred between buyers and sellers. If sellers are able to push the S&P below this recent support level, more losses for stocks are likely to follow.
I Received an Urgent E-mail Alert from My Lumber Contact By Tom DysonMonday, July 6, 2009
I was at the New York Mercantile Exchange on a day when oil made a new all-time high. This was in 2005 during the big bull market. I was standing next to the crude oil pit at the precise moment it made the new high. The energy was incredible...
Your Dream Retirement Just Got 50% Cheaper By Dr. David EifrigThursday, July 2, 2009
Florida has always been a Mecca for retirees. The warm weather and zero state income tax have drawn folks for generations. But during the housing bubble of the 2000s, growth in places like Port St. Lucie spun out of control...
The Best Book I've Read This Year By Tom DysonWednesday, July 1, 2009
The irony is, the secrets to living a prosperous and fulfilling life are not really secrets at all. We know them all already... self-discipline, generosity, charity, patience, virtue, etc. The Greeks knew them. The Romans knew them. And hundreds of others have documented these lessons since.
This Sector Is About to Explode By Dr. Steve SjuggerudTuesday, June 30, 2009
The biggest rally started in the late 1980s (+1,347%). The next biggest started in the late 1990s (+646%). Here in the late 2000s, the time is right again.
