Vanity Fair: Will California Sink the United States?

Michael Lewis has an insightful article in the November 2011 Vanity Fair analyzing the health of U.S. state and local governments. Although the article never answers the question posed at the top of the cover, Lewis unearths some interesting tidbits we can use to predict the future economy.

Because there are so many moving parts to this analysis, I will go directly to the main points.

State governments are not informed about the financial health of their municipalities.

Lesson: State and local governments don't communicate. They don't have time, and they don't care.

California has perhaps the worst finances of any U.S. state, according to Meredith Whitney.

Lesson: Lewis' implied point is that the rest of the U.S. will suffer the same fate. I disagree with this thesis, as we will see below.

Meredith Whitney's prognostication about municipal bankruptcies was far off the mark.

Lesson: She wasn't actually interested in making that prediction at the time, she was interested in identifying states that would survive the financial crisis best. The publicity was, perhaps, accidental.

Arnold Schwarzenegger doesn't look where he is going, even in traffic, on a bicycle, without a helmet. Is that the way he tried to run California?

Lesson: No, it wasn't. His attitude may have seemed classically Californian--bold and direct, while irresponsible and rash--but his tenure in office was directed by voters who refused to vote for better government. The legistators that opposed his attempts at reform were following the dictates of their constituents.

Lewis see a kind of "vicious cycle of contempt" for politicians, in which failure to make progress causes voters to be more disgusted with them.

Lesson: Mixed. Although there may be contempt from various corners, the voters continued to vote for specific policies that their public officials carried out. Both may be irresponsible, but they are in harmony. The debt and finances of the State mirrors that of the people, with average incomes of $43,000 and debt of $78,000 per capita.

San Jose, a city in Silicon Valley that should be well-off financially, is nevertheless in dire straits.

Lesson: Municipalities in California acceded to demands that public sector workers share in the "boon" generated by California's high tech workers. The promises made greatly exceed the cities' ability to pay.

Even worse off is Vallejo. The city manager there sees the problem as one of attitude, not finance.

Lesson: Municipalities in California have poor finances because of values among their citizens and city workers. This cause is barely recognized among citizens in California, and is barely elaborated on by Lewis.

Discussion

If you read enough internet articles about California's financial crisis, eventually you will find comments from readers saying things like "we're the 8th largest economy, so pay attention" and "what happens to us will happen to you." Why is this?

In 1982 John Naisbitt published a bestselling book titled "Megatrends" in which he claimed that trends occuring in a few states, of which California featured prominently, seemed to presage national trends. His method, based on content analysis of major newspapers, seemed sound, and mostly matched our intuition about trends. Nearly 30 years later, it seems that the California collective subconscious is still stuck with this conclusion. How can a voter in California mess up their vote when whatever they do will be a harbinger for the rest of the U.S.?

But California is no longer a harbinger. The attitudes and decisions made there don't reflect the values of the rest of the country, don't supply leadership, and the rest of the U.S. recognizes it. Hence, to understand the state of the world as an investor you can no longer use California trends quite the same way, and that includes the data in this article.