Psychology of the Bailouts

Includes: BAC, C, DIA, GM, JPM, QQQ, SPY, XLF
by: Kevin Mackey

As of January 14, 2009, the Federal Reserve’s balance sheet totaled $2.1 trillion dollars. It actually decreased in the past week, but not by much - especially when you consider that it has grown $1.2 trillion since January 16, 2008. To me, this increase does not receive enough public attention. If you look at the Federal Reserve’s balance sheet, hundreds of billions of dollars have gone to aid the money markets, foreign central banks, the Treasury, discount window loans, swaps, and repurchase agreements to name a few. A lot of this money went to the banks and other financial institutions.

People like to object about these “bailouts” for multiple reasons. Some, because it goes against the thinking of the free market. Others, because those that made selfish and destructive decisions are first in line to get money as opposed to the people struggling to weather the storm. It stings, but we have to understand why these actions were necessary.

Psychology is a powerful tool. Psychology explains a lot of what happened from September 15 to November 20. Psychology is still very much present in the market today, as evidenced by what happened Thursday. If the free market took over, the pain would not last as long, but it would be much more harsh. Since we don’t live in a box, we cannot even estimate the fallout of not intervening because of the uncertainty of people’s behavior. Outside of a very large financial blow in the markets, I believe fear would lead people to run their businesses as if funding from some of traditional sources was literally wiped out to them forever. To operate as a going concern, based on these expectations, decreases in employment, spending, consumption, and demand would be a certainty. It would make what we experienced in 2008 feel like a 125 point day during October.

The above paragraph is obviously a generalization. There is a chance that the market and human reaction would be better than I expect, but why would we want to run the chance that not approving stimulus or bridge loans could lead to the mortal destruction of our economic system?

Our politicians are the ones that ultimately have to choose for or against these initiatives. Hopefully they make their decisions based on what they view as the best wishes of their constituents. Sometimes they are believable, but the nature of politics is generally polarizing. Does this scrutinizing condemnation of politicians’ actions rub off on our daily lives? Even though we don’t cast the vote that decides legislation, have you ever considered why non-politicians essentially make arguments to shape our opinions just like the politicians we castigate?

If this past year taught us anything, it is that we should focus on being open and realistic, as opposed to blaming and being closed to alternative ideas. Blame mode keeps us from thinking rationally because our mind has already been made up. Strong feelings are thought to change. They often cause us to search for confirmation of being right as opposed to considering being wrong. But what happens when the plethora of information already provides us with an easy answer in an article or an interview?

Just since September, a lot has been written, said and predicted about the financial crisis. Most of it has been wrong. Just as psychology is variable in the way we respond to certain events, it is also variable in the way we form our opinions. It is very good to bring in the information from these sources, but we must be aware not to let their opinion automatically become ours. I am afraid too often in this country, people let others make their decisions for them.

To demonstrate my point, consider TARP funding compared to Fed funding. Based on discussions I have had in the past couple of months, people have strong feelings about TARP funding, but not much opinion about the blowup of the Fed’s balance sheet. Is it a coincidence that media discussion is much more focused on TARP than the Fed? Did this start because of the difficulty TARP had passing the Senate? Do you think the corporate nature of the media has unconsciously conditioned us as the outcry over the TARP funds, but not over the huge balance sheet increases at the Federal Reserve, suggests? Should there be forms of blame discussions to hold people accountable for their actions or are they getting in the way of progress?

What do you think?