California Dreamin'

The pall of insolvency hangs over Los Angeles like the smoke from a brush fire. Fire is such a hazard in California that inspectors roam the hills around the city looking for dead wood. Residents are fined if it is found on their lots. But no such penalty awaits those whose financial tinder poses a risk.

We have come to California to look into the future. America may lead the world. But the Golden State leads America. The state is a hothouse of invention…always innovating…always evolving…at such a fast pace the rest of the world gets dizzy trying to keep up.

Detroit may have given the nation the cheap automobile…but L.A. knew what to do with it. It built suburbs all up and down the coast…and then connected them with a network of freeways. Gasoline was cheap. Houses were cheap. And the roads were open.

California is a land of dreamers. Bubbles, like tropical plants, grow big and fast here…creating vast canopies of delusions and conceit. Then, the hot sun beats down and the dried-out dreams fall to the ground as kindling…waiting for a spark.

In the late ’90s, the Silicon Valley was the source of a great reverie – that computer technology would transform the world. It has. But not exactly as the hopers hoped. Their dotcom bubble went up in smoke at the end of the decade.

Then, came a group of new bubbles – also largely based in California. The feds panicked in the recession of ’01-’02. Their artificially low interest rates – combined with the globalized economy – caused the final mutation that produced the Extreme Bubble Culture circa, 2002-2007. Housing prices rose, giving consumers the collateral they needed to dream big. Soon they were borrowing money so they could buy German cars, fill their tanks with Saudi oil, and drive to malls to buy Chinese gadgets.

Everyone speculated on housing prices – homeowners, lenders, investors, builders, and Arnold Schwarzenegger’s state government itself. But now that housing prices have come down…the whole Bubble Culture may be threatened with extinction. We drove into the heart of L.A. looking for evidence. Our first challenge was to find the heart of the city. The place stretches for many miles in many directions. It has a head…a mayor and a city council, easy to locate in a stately old building. It has long arms too – reaching out to grab parking offenders and collect property taxes. And its legs are in constant motion; the city is always on the move.

What it seems to lack is a heart. The downtown area is just a collection of office buildings. In the morning, people drive in, park in garages, and go directly to their offices. In the late afternoon, the legs turn and move in the opposite direction. By nighttime, the place is as dull and empty as a state senator’s head.

The brain is missing too. When ordinary citizens dreamed of riches, so did the state government. Now, the weightlifter faces bankruptcy for the 2nd time since he’s been governor. When he was sworn in, the state was threatened with default on $13 billion worth of loans from the previous administration. This time the stakes are higher.

California led the nation on the way up; it’s leading on the way down too. When the value of the collateral broke down in 2007, Bubble Culture turned brown. Homeowners went broke. Their lenders went broke. And pretty soon, the whole world was beginning to go broke. In the last two years, house prices in California have fallen 40%…50% in some areas.

Driving through the city, most of the older neighborhoods show few signs of trouble. There are few “For Sale” signs up. Life goes on in the same way it has since this culture began early in the 20th century. It’s in the open areas outside the city, where the dreams got most sun, that the trouble begins. Just drive down Lincoln Street from Santa Monica to the airport. When you come to Marina del Mar you will soon notice huge housing developments on both sides of the road. “Now Leasing” says one. “Luxury Units for Sale” says the other. No lines were seen outside the sales offices. Throughout Southern California there are thousands of these new houses…mostly at the fringe of stretched-out suburbs and outlying towns…many of them practically deserted. It was the rare developer who imagined that prices would be cut in half.

Naturally, when the bubble blew up…so did California’s state budget. Suddenly, tax revenues collapsed…while expenses rose. This was completely foreseeable to a person off normal intelligence; it nevertheless seemed to come as a complete surprise to the legislature. For months, the government has warned that it was running out of money. In this too, California leads the nation. Not only are its people going broke – so is its government. When this year began, the government faced a $42 billion deficit and was forced to pay its employees in IOUs.

Unlike the federal government, California can’t print money. But between issuing IOUs to employees and issuing dollar bills to foreign lenders there is not a lot of difference. Whether they have the emblem of the Great State of California or that of the United States of America, both pieces of paper will come to be worth what people will give you for them…and not a penny more.

Bubble Culture now seems tawdry, out-of-fashion and broke. But Californians are still dreaming. When the underbrush finally is burned away, perhaps they’ll dream up something new.

The Daily Reckoning