Thursday, June 05, 2008

Surprise! The states are out of money again.

In a weird way, state governments are like banks: they have a fundamental and inevitable duration mismatch. Banks loan money long and borrow short (a demand deposit, aka your bank account, acts in crises like a renewable daily loan); under the right (wrong) conditions, the short lenders flee and the bank collapses.

This is not a perfect analogy with state governments of course. But they make long promises with only short funds, and when long and short durations collide, disaster can occur--just ask John Lindsay. Plus both have an implicit guarantee from the Federal government that allows them to be less fiscally responsible than they ought.

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