A Different Liquidity Crunch

I wanted to make this simple idea into an bigger op/ed, but let's start here... :)

So, the credit crunch has resulted in a loss of faith among borrowers and lenders. Lenders only have so much money to ration among borrowers, but they can no longer decide who is a good risk and who is a bad risk. Good borrowers are suffering from the "credit drought" because they cannot separate themselves from the bad borrowers who are more likely to go bankrupt than repay their loans.

The situation with water in California is similar. There is "not enough" water for everyone, so the Bank (i.e., the Drought Water Bank that DWR has set up) is trying to ration its water among many "borrowers" -- all who claim to deserve the water.

In theory, the Water Bank should work like water does, i.e., it should be:

• Transparent
• Cool (logical)
• Easy flowing

But, instead it is opaque (buyers and sellers must qualify via DWR's beauty contest), hot (political negotiations) and dammed (bureaucratic allocation, price, etc.)

As a result, water (like credit) is not flowing to those who value it most, but to those who have the best political connections, bureaucratic friends, and/or ability to manipulate the "allocation formulae" in their favor.

Those who merely have a strong desire to buy or sell are left to pursue more expensive options.

[The parallel between credit and water is not total. The credit market froze because "bad borrowers" issued too many opaque bonds with long maturities. Since water is not the same -- buyers are paying spot cash for short term flows -- the failure of the Water Bank is less-forgivable.]

Bottom Line: The damage from misallocation of water is just as important as the damage from misallocation of credit. The pity is that DWR appears to be intentionally mangling the process of reallocating California's water.