More California Foreshadowing

We have been watching the state of California and wondering if their problems could be giving hints of what is coming for the entire country. Remember that bell bottom pants, skateboards and RayBan sunglasses all started in California....and then 5 years later finally made it to Midwest.

Today there is an article about California's bond auction that gives more hints.

Remember when a state or country is out of money, they need to sell bonds. Bonds are really just promissory notes.....they promise to pay a stated amount of interest over a stated period of time and at the end of that time they pay the principal back in one lump sum.

The worse the credit risk...the higher the interest rate that investors are going to demand. The higher the interest rate....the more of your cash flow goes out the door to service it. Think about a credit card that is charging 6% and then jumps to 20%. It becomes near impossible to keep making the payments....which can cause a snowball effect because it becomes difficult to keep making the payments on the house, car, boat, ATV's and everything else if more of your money is going towards your credit card payment.

That's what IS happening in California.

For example, the 13-year bond in this week’s deal will pay an annualized tax-free yield of 4.85%, compared with the 4.47% yield on the 13-year issue in the previous bond sale. Higher interest rates mean servicing the debt takes a bigger chunk of the state budget.

Read article here; http://latimesblogs.latimes.com/money_co/2009/10/california-muni-bond-sale-erb-general-obligation-muni-tax-free.html

We actually thought that the rates demanded would have been higher than 4.85% seeing what a hole the state is in. But with banks paying less than 1% on savings accounts, investors are currently desperate for some other options. So for now California can continue to keep spending today with plans to keep kicking the can ever further down the road.

But someday.....the piper will have to be paid.