Trying to find a politician who thinks the next bailout is a bad idea is like looking for the CEO of a bankrupt company willing to forfeit his fat severance package – they are a rare breed indeed. And this time around that rare breed is someone like Alabama Senator Richard Shelby. In an interview on Bloomberg this week he described the situation, admitting that he is popular on neither side of the aisle. What has made him so unpopular? He refuses to sign on to the $700 billion bank bailout and believes it is a sellout of the American taxpayer.
A credit crisis is never pleasant. It’s kind of like having a national root canal. But having a credit crisis on the eve of an election is dangerous indeed. Why? Politicians on both sides of the fence have agendas that they generally keep to themselves. But throw them into an election and we quickly learn that these agendas serve one purpose and that is to get elected at all costs.
As the world waited for the clowns and jokers on Capital Hill and Wall Street to finally agree on who gets what in the latest $700 billion bailout, one only had to watch the financial news this week as Barney Frank and company did their best to discredit the current administration. They went as far as issuing the implicit threat that if the government delayed, people on Main St. would suffer greater hardship. It was a shameless display of politicking to exploit the situation. Next will come another bailout out for beleaguered homeowners who paid too much for their properties and now 11 million of them have mortgages worth more than the value of their properties. So now the taxpayer must pick up the tab "for the common good"?
The dismal truth is that so far, bailouts have failed to work. Will this one be any different? Undoubtedly, it won’t be the last. But this situation reveals a disturbing trend. In an election year, politicians will stop at nothing to gain public approval even though it means sticking their constituents with the ultimate exorbitant bill for their short-sighted and expensive "fixes."
Such policies do not solve the problem, they only prolong the pain. They are highly inflationary and even if they do temporarily work, result in rapidly eroding buying power as government deficits soar and the value of the dollar plummets. Throughout history, such efforts by government have an abysmal record. Yes, such policies are temporarily popular and win votes from those looking for a quick and painless fix at election time. But the price we all must pay goes up substantially and only serves to prolong the agony.
Banning short sales is a classic example. Until the recent action by Russia, the U.K. and the U.S., the only countries to have banned short selling in recent memory were China and Zimbabwe according to Larry Williams. Are you kidding? So now the U.S. is taking the lead of a communist state and the world's economic basket case with a 19 million percent annual inflation rate (and the most corrupt political leader in Africa)? I wonder how many legislators or regulators have studied history? The answer seems obvious – no one. If they had, would they knowingly push measures that have clearly failed in the past?
Every time short sales have been either banned or restricted, the effect has been the opposite of what was intended – after a temporary lift stocks continued to fall as confidence in markets and the financial system was eroded. We have to go all the way back to 1930 to see when similar action was taken by government in the U.S.
According to Williams, in the wake of the 1929 stock market crash on April 1, 1930, a new exchange rule put curbs in place on short selling that required brokers to first obtain written consent from clients to borrow stock. Markets rallied on the rumor but look what happened to the Dow Jones Industrial Average shortly afterward (see Figure A).
Figure A – Weekly chart of the Dow Jones Industrial Average showing the temporary impact of the last time restrictions were place on short selling following the 1929 correction. Chart by Metastock.com.
These misguided bailouts and bans may seem like a good idea at the time and appear to have gained public support if recent election polls are any indication. But this action does not change the inevitable albeit painful reality.
Recessions are a necessary part of maintaining healthy capital markets long-term. They remove excesses that have been built up over years of easy money and rapidly appreciating asset prices as the inevitable bubbles build. To try to interrupt this cycle makes about as much sense as trying to suspend the law of gravity. The problem is that such action only extends the pain that in its worst form turns into a Japan-style economic recession that lasts decades instead of a year or two.
Stock position: None.
