And with a wave of his magical pen, the Governator made it all better for California.

Or not.

After weeks of hard-fought partisan debate and nights spent on couches in the Capitol building, California's legislature finally managed to hammer out a budget that closed most of the US$42 Billion deficit now hanging over their heads.

For the first time in 17 years, the bill raises sales and income tax rates for Californians while cutting spending by about 11%...surely a task for California's "shopaholic" politicians.

And the markets seem to be reacting favorably to state governments' measures to handle the crisis. According to the Wall Street Journal, investors plowed some US$1.46 Billion into municipal bonds in a single week this February.

With US Treasuries now paying pitiful yields and two and five-year municipal bond yields narrowing by over 1% in the last six months, munis are starting to look like an appealing alternative. You can collect a greater coupon and possibly even some capital appreciation from falling yields.

But there's "more than meets the eye" when it comes to state governments and their Triple-A rated debt.

Making the Federal Government Look Great

We don't have to tell you, dear friend, just how poorly governments tend to do their jobs.

But what we can share with you is the shocking range of just how bad some governments can do...indeed, in some cases even making the Federal government look like a model of fiscal discipline and political efficiency.

Take California, for instance. Specifically Vallejo County.

A Google search will turn up dozens of quick, nightmarish results about just how poorly this municipality managed its affairs. Of 100 firefighters in the county, 21 were earning over US$200,000 per year. Police captains were paid an annual salary of US$306,000. In 2007 alone, 292 city employees earned more than US$100,000.

All in the same state as Contra Costa county, where 40,000 lined up to vie for one of the 350 available section 8 vouchers.

Wait...what?

If it's any consolation, Vallejo county has since declared bankruptcy. But there's no bringing back the tax money that paid those lavish police-and-firemen salaries...so Contra Costa is ‘up a creek' as the saying goes. But California doesn't have a monopoly on unbelievably generous taxpayers.

Even our home state of Florida is getting involved...as demonstrated by Polk County Sheriff, Grady Judd.

He earns US$149,000 for his work as sheriff in Polk county, an amount he insists to be justified by the rigorous demands of Sheriff-hood. But Grady is what's known as a "double-dipper." Having retired originally in 2005, Judd came back to work with Polk county...collecting not only a pension, but another paycheck from Florida taxpayers.

In addition to his generous salary, he collects benefits from Florida's Deferred Retirement Option Program (DROP) to the tune of over US$70,000 per year. And that's after DROP paid him a US$350,000 lump sum upon his original "retirement" in 2005.

My, aren't we generous.

Speeding up the Slowdown

Now those are only a few - slightly superlative - examples of just how poorly state governments govern. We don't have the time for an in-depth analysis here, but it goes without saying that baboons would've done a better job...really.

Just take a look at the graph at right - from January's "When a Trillion Dollars Just Won't Do..." A-Letter - and you'll see the kind of basket-case instability that goes hand in hand with the practices of Vallejo and Polk County.

It's immensely important that you keep in mind; that's how state governments performed during the boom years...waffling back and forth between budget surplus and shortfall. How do you think they'll fare as the bust starts to sink in, deflating tax receipts on everything from consumer goods to homes and businesses.

(For an idea of just how far and fast these tax receipts are dwindling, take a look at the graph below.)

And it's not stopping any time soon. One report estimates that annual state budget shortfalls could top US$180 Billion by 2011.

So you can see that disastrous mismanagement on the part of state and municipal governments has quickly burned through surpluses and actually served to speed up a slowdown in tax revenues and general economic activity.

That's why "Municipal bond investors shrugged off [the] deal in California to close [the] $42 billion budget gap, saying the agreement, which relies on borrowing, won't address the state's chronic deficits."