Buy On Rumor, Sell On News

Wayne Lusvardi: In California, polls show that new Gov. Jerry Brown’s proposal to extend $5.9 billion in “temporary” income, sales, vehicular license fees, and tobacco taxes instead of letting them expire has an unlikely chance of passage in June 2011.  The electorate fears that the politicians will back down from a confrontation with public unions and will extend the four taxes for five years. The Democrats would then not have any incentive to reduce pension liabilities or cut state entitlement programs.

Thus, California, along with New York, New Jersey, and Illinois, would have to choose between insolvency and a bailout by the Federal Reserve.  A congressional bailout of California has been precluded by the Republican takeover in the U.S. House.  Midwestern states don’t want to bail out California or pay for their Obamacare or benefits for illegal immigrants.

The rumored Fed bailout would thus occur no later than early next year with the approval of the Obama Administration.  This would entail the Federal Reserve buying California’s debt bonds similar to the Troubled Asset Relief Program (TARP).  The speculated Fed bailout of California would be based on the rationale that these states are “too big to fail” and that without a bailout the bond markets would fail nationwide.  A TARP-like bailout of California would likely socialize its debt whereby everyone would pay for it via monetary inflation.

There is a saying on Wall Street: “Buy on rumor, sell on news.” In other words, put your money on rumor; pull out your money on news.  Bond markets are already spooked about municipal bonds such as the state of California’s – (read: Muni bond yields jump again after New Jersey governor uses the ‘B’ word,” (L.A. Times, Jan. 13, 2011).  Muni bond interest rates have climbed a full 1 percent since the November 2010 election.

One of the reasons the bond market is spooked is that the numbers in Gov. Brown’s budget are just based on a multitude of risky assumptions and prophecies that may never transpire. If all the stars do not line up right in Gov. Brown’s “Moonbeam” budget, the state is back to a $20 billion to $25 billion deficit and a plausible death spiral.

JAN 20

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