Amidstthe storm of budget "compromises" currently being turned into cause fora full-blown election circus, one in particular seems to be getting adisproportionate amount of attention, given its seemingly apoliticalnature.
That measure is Proposition 1C, a proposal to, as the Legislative Analyst's officeeuphemistically puts it, "allow the State lottery to be modernized."
However, what the bill actually does (as the Legislative Analyst lateradmits) is allow California's government to borrow against future Lottery profitsin order to pay off the mountain of debt we already have to pay off andseem unable to do without making genuinely courageous political moves.This is a bit like walking into a bank and asking to put a secondmortgage on a house you may buy in the future so that you can pay offthe mortgage on the house you have now.
Sounds exceedingly silly,right?
No politician would ever borrow against the creation of future wealth in order to bail out contemporary failures, right?
The Legislative Analyst's Office has certainly picked up on thebill's rather tenuous connection to remedying fiscal reality, as wellas a graver problem. That is, the analyst reports that even "after theincreased lottery profits are used to make debt-service payments toinvestors, the remaining profits probably would not be enough to coverthe General Fund's higher payments to education for most of the next 20to 30 years." Lovely! So glad to know that the 40% of our budget we spend on educationis an even larger obstacle to the salvation of the current budgetcrisis than we thought. And how pleasant that our second mortgage onour hypothetical house won't even pay for the mortgage on the firstrundown wreck!
This pessimistic angle put forward by the LegislativeAnalyst's Office is by no means the only perspective available. Infact, Schwarzenegger's primary economic advisor, David Crane, recently blasted the LAO report as incorrect in a meeting with the San Diego Union-Tribune.
"The LAO was dead wrong to liken it to conventional borrowing," Craneargued, adding that the misunderstanding sprang from the LegislativeAnalyst's Office's failure to comprehend the difference betweensecuritization and outright borrowing.
The distinction is worth making, but unfortunately, hardlyencouraging. As any follower of the current economy knows, many wouldhear "securitization" and have a sudden urge to bolt as fast as theycould in the opposite direction. Why? Because, as one finance website puts it, "A typical example of securitization is a mortgage-backedsecurity (MBS), which is a type of asset-backed security that issecured by a collection of mortgages."
Yes, that's right, the typicalexample of what Crane and his friends are doing is precisely theunsustainable, irresponsible practice that got the financial systeminto this mess.
However, the problem isn't with securitization itself, whichbasically means taking large numbers of a particular type ofasset-backed debt, pooling them all together and then selling pieces ofthe pool to other people. In finance, this is a relatively routineprocess, but its main success lies in the part where the pieces of debtare sold. So what does the California lottery proposal wish to do?Borrow against the California lottery, and then sell pieces of the debtback to private investors. There's just one very substantial problem -who is going to buy debt from a State as lax about that very subject asCalifornia? Perhaps a terribly optimistic financier or two may takepity on the State, but otherwise, these securities are likely to sitand rot with their originators, meaning that large portions of themeasure are very likely to reduce to borrowing.
So as far as David Crane's argument that borrowing andsecuritization are not the same goes, the argument is semanticallycorrect, and that is almost all. In practice, Mr. Crane might want topronounce "borrowing" as "securitization," but whether you call atomato a to-mah-to or not, it's still a terrible idea.
